Changes in legislation make the choice more complex today.
If you’re setting up a business for the first time, one of the key choices you’ll make is over how you choose to structure it. The simplest option is often to become a sole trader or, if there are two or more individuals in business together, a partnership. Many businesses start life in this way.
Alternatively, some might set-up in business as a limited company, appointing themselves as company director. There is no right or wrong answer here, but the way in which a business is structured will probably depend on a number of factors including possibly the business owners’ personal circumstances and the likely profits of the business.
It’s worth remembering that the Taxes Acts and the Companies Act are vast and complex, which means it’s important to get support from those who have knowledge and experience of the rules.
If you are a sole trader, you do not benefit from ‘limited liability’ and as a result are potentially at risk of losing your own personal assets if the business fails. A company is a separate legal entity and therefore it is possible for the business owner(s) to benefit from ‘limited liability’.
Administration and formalities
If you run an unincorporated business, you prepare annual business accounts and a Self-Assessment tax return. The accounts are not filed at HM Revenue & Customs or Companies House, although some of the information contained within the accounts is declared on the tax return.
If you run a limited company, you are required to prepare accounts in a specific Companies Act format. Company accounts are filed at HM Revenue & Customs and at Companies House. You need to observe certain formalities before taking profits from a company, including the necessary recording of board meetings. It’s possible to pay salaries and bonuses, provided the company operates a payroll scheme.
Rates of tax and national insurance contributions
As an unincorporated business owner, your tax and national insurance contributions on profit are at rates of 20% (basic rate), 40% (higher rate) and 45% (additional rate).
In addition, class 4 national insurance contributions are due on profits falling between £8,060 and £43,000 at 9% and 2% on profit over £43,000. Class 2 national insurance contributions of £145.60pa are due if profits exceed £5,965.
Regardless of the value of the amount you draw, tax and national insurance contributions are due on the taxable profit of the business.
As a company owner, you are able to control the level of income on which you pay tax by drawing only the level of income required to fund your lifestyle. Depending on circumstances, it is also possible to control the type of income on which you pay tax by voting yourself a tax-efficient remuneration package.
Companies are currently subject to corporation tax at 20%.
Should I review my existing business structure?
The Finance Act 2015 introduced major changes to the way in which business owners are taxed on profits extracted from a company - in particular by way of dividend. These included:
- the abolition of the notional 10% tax credit on dividends;
- a new £5,000 tax-free dividend allowance;
- and a new rate of taxation on dividends of 7.5% (basic rate taxpayers).
For most small business owners the result of these changes will be an increase in taxation.
In light of the changes introduced in the Finance Act 2015, business owners should consider whether the vehicle through which they trade is still appropriate for them and, if trading as a company, whether they are extracting profits in the most tax efficient manner. That’s why it is always worth having a discussion with your accountant or tax adviser about the most appropriate option for you.