Limited Company 'v' Sole Trader - the tax comparison

Minimising the overall 'tax leakage' is a key aim for all businesses. Despite the Chancellor's five attempts to increase the corporation tax assessed on small limited companies, most recently in his 2008 Budget, the tax benefits of trading through a limited company still remain attractive for businesses with modest profits.

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%

From 1 Apr 08 - Profits up to £300,000 taxed @21%

As the illustration below highlights, based on the UK tax rates and thresholds for 2009/10, the corporate medium still results in the lower overall tax charge (allowing for the extra professional fees incurred through trading as a company), whilst profits are between, approximately, £12,000 and £400,000:

Note

In the above comparison it is assumed company profits are extracted first by a salary of £5,715, 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 issues,
  • 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),
  • The tax costs of running a car, that is also used privately, within the business,
  • The more generous corporation tax expense deduction regime for purchased goodwill, other intangible assets, research and development costs, private use of mobile phones and computers,
  • The tax and timing aspects of 'exit routes', including gains on substantial shareholdings,
  • 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. This can also assist with eligibility to Child Tax Credit,
  • Future, further detrimental changes in company corporation tax rules, the expected introduction of income shifting rules, etc .
• Commercial matters:
  • Litigation (including claims relating to Health & Safety, insolvency and commercial matters) protection (unless fraudulent or wrongful trading),
  • The importance of keeping financial results and other business information confidential,
  • Image and credibility in the marketplace (including when seeking credit from a new supplier),
  • The increased risk of "passing off" litigation that arises through the, arguably, higher visibility of trading as a limited company.
• Cost and practical matters:
  • The possible need for a statutory audit, if turnover exceeds £5.6m,
  • The additional administration work and professional fees (startup, ongoing and exit) associated with trading as a limited company,
  • Keeping personal finances separate from company finances (including the additional management involved in calculating and transacting permissible dividends, compared to drawings),
  • Pension and personal mortgage issues,
  • Motor and General insurance considerations,
  • Where an established unincorporated business is converted into a limited company, this may initially have adverse affects upon the credit rating your suppliers have previously given you,
  • Use of certain words (eg Group) in the company.

The decision of which trading medium to trade through should be based on many factors, and will usually require professional guidance. If minimising the taxation on profits is a key concern, and these profits are modest, trading as a private limited company, as opposed to being a sole trader or partnership, is still an attractive option.

Other Practical Examples of our Tax Planning Expertise

Minimising the tax cost of operating a vehicle for both business and private useage. Self administered pensions as onshore tax havens for owning commercial property.

Advising on salary sacrifice and employer funded pension contributions. Convincing the Inland Revenue that outstanding tax should be waived when it originates from their coding errors/delays.