Specialist

The basis of taxing small company profits over recent years:

Up to 31 Mar 00 - Profits up to £300,000 taxed @ 19%
1 Apr 00 to 31 Mar 02 - First £10,000 profits taxed @ 10%
1 Apr 02 to 31 Mar 04 - First £10,000 profits taxed @ 0%
1 Apr 04 to 31 Mar 06 - Profits extracted as dividends taxed @19%
1 Apr 06 to 31 Mar 07 - Profits up to £300,000 taxed @19%
1 Apr 07 to 31 Mar 08 - Profits up to £300,000 taxed @20%
1 Apr 08 to 31 Mar 11 - Profits up to £300,000 taxed @21%
From 1 Apr 11 - Profits up to £300,000 taxed @20%

As the tax calculations below illustrate, based on the UK tax rates and thresholds for 2013/14, a limited company still results in the lower overall tax charge than a sole trader (allowing for the extra accountancy fees incurred through trading as a limited company), whilst profits exceed approximately £15,000 pa: 

Note
In the above comparison it is assumed company profits are extracted first by a salary of £7,600, with the remainder drawn as dividends. It is also assumed in both mediums that the proprietor receives no other taxable income and that there are no associated companies.

As well as the amount of direct taxation due on profits, businesses should consider a number of further issues before deciding which of the two trading mediums is most appropriate:

Other tax matters

• IR35 tax issues (consider using an umbrella company if IR35 would apply to your contract),
• The ability to extract or retain profits in a different manner and the use of other family members' tax allowances and reliefs (subject to section 660 settlement legislation rules), 
• Timing of tax payments,
• The profit or loss profile of the business over time (particularly with regard to use of losses and lower early year profits),
• Tax relief for running a car, that has both business and private use,
• The more generous corporation tax rules for purchased goodwill, research and development costs, private use of mobile phones and recovery of sub-contractor CIS deductions,
• The tax treatment upon business exit,
• For unincorporated businesses converting into a limited company, the ability to crystallise the goodwill of the business and extract this tax free from the new company. For many businesses, this can be used to avoid paying higher rate income tax for a period after the incorporation. This can also assist with lowering your taxable personal income and hence improving entitlement to Child Tax Credit,
• Sheltering assets (investments, real or intellectual property) with potentially appreciating value from double taxation.
• Future, further unforeseen changes in tax rules.

Commercial matters

• Protection against claims arising from:
  • Trade litigation,
  • Onerous contracts (including property leases and royalty agreements),
  • Insolvency (particularly relevant during recessionary times),
  • Employment tribunals (notice pay, redundancy & tribunal awards),
  • Health & Safety,

• The importance of keeping financial results and other business information confidential (although the use of our address as Registered Office and directors' services address, plus filing minimum disclosure abbreviated accounts on the public record at Companies House, can help with this),

• Image and credibility in the marketplace (including when seeking credit from a new supplier),

• Avoiding the situation that might arise where a client refuses to engage consultancy services from a sole trader (to minimise their risk of a claim from HMRC that such an arrangement is actually 'disguised employment'),

Cost and practical matters

• The possible need for a statutory audit, if turnover, gross assets or number of employees exceed the thresholds,
• The additional paperwork, other administration work and professional fees (startup, ongoing and exit) associated with trading as a limited company,
• The discipline required in keeping personal finances separate from business finances (including the additional management input required in calculating and transacting permissible dividends, compared to the simpler rules for sole trader drawings),
• Pension and personal mortgage issues,
• Motor and General insurance considerations,  
• Credit rating,
• Use of certain words (protected and 'similar to') in the business name.
• How long into the future that you believe the business will continue to trade.

If you require assistance understanding and going through these various factors, to decide whether a limited company or sole trader structure is best advice for your particular unique circumstances, please contact Ian Piper for a free initial consultation.

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