A significant number of small businesses in the UK do not take full advantage of HMRC-approved...
In this article, we outline the key advantages of making the jump from a self-employed setup to a limited company.
The simplest and most straightforward way to open a business is as a self-employed sole trader. As a sole trader, either on your own account or in partnership, you run your own business as a self-employed entity.
A sole trader needs to ensure they are registered with HMRC by completing an online SA1 form and must file a tax return annually. They may also need to register and account for VAT. This allows for a relatively easy set up in the early years of a business.
A self-employed individual effectively treats both their business and personal tax affairs as one, with profits treated as income and taxed accordingly and the personal transactions kept out of the calculation.
If you are self-employed and your business is growing, then you might be considering making the jump to working through your own limited company. A limited company is a completely separate legal entity and the question of whether this move would be worthwhile is dependent on numerous factors.
However, for many successful self-employed businesses, a change of status to a limited company offers a multitude of important benefits. This can include considerable tax savings under the right circumstances and as a general rule we advise that a profit of £30,000 per year - and expected to grow - is the level at which you should start to look to incorporate into a company.
We have listed below some of the most important benefits to working through a limited company.
- Separation of business and personal finances. The limited company is a separate legal entity and the actions of the company are not legally ascribed to you.
- The concept of limited liability means that your personal assets cannot usually be used to pay company debts. This may not always be the case if directors have been required to provide personal guarantees, for example for a bank loan.
- Tax rates are usually lower for companies although your salary will remain liable to Income Tax. There can be significant personal tax benefits to trading as a limited company with various options available as to how to extract money from your limited company including a ‘low salary – high dividend’ approach. A limited company can also re-invest profits far more efficiently than the self-employed.
- If your limited company is sold there can be other tax benefits. For example, when you sell qualifying shares in a trading company you will be able to claim Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief) so that you only have to pay 10% CGT rather than the normal rate of 20% on the first £1,000,000 of capital gains.
- Working through a limited company also provides more options to raise finance. This is normally the case as banks are more comfortable working with limited companies and there is a wider array of borrowing options. There are also more investment opportunities. This can make it easier to expand and grow your business.
- Some businesses will only work with limited companies as there are more checks and balances. This can also enhance the appeal of your business.
If you convert a sole trader business to a limited company then a capital gain will be deemed to arise. This could give rise to a chargeable gain based broadly on the difference between the market value of the assets and their original cost.
In most cases the incorporation of the business will be done in such a way so as to satisfy the conditions necessary to secure incorporation relief. The incorporation relief means that you won’t pay any Capital Gains Tax until you sell your shares in the business.
It is important to note that where the necessary conditions are met, incorporation relief is given automatically and there is no need to make a claim. The relief works by reducing the base cost of the new assets by a proportion of the gain arising from the disposal of the old assets. To qualify, you must transfer all your business and its assets (except cash) in return for shares in the company
If you decide to go ahead and make the jump to a limited company, it must be remembered that operating a limited company can be far more complex than working as a self-employed person. In order to set-up a limited company the company must be registered with Companies House and at least one director must be nominated. The formation process can be relatively time consuming if you do not have the expected information that an accountant can get ready for you.
HMRC will need to be notified within 3 months of starting to trade through your company, and you must register for Corporation Tax. You must also let HMRC know that you have stopped working as a Sole Trader. If you were already registered for VAT, then you will have to cancel your VAT registration and re-register through your limited company.