Is It Better To Be Self-Employed Or Use a Limited Company?

Author: George Ian Hope BAcc(Hons), MSc(IT), FCCA, CGA, CPA

Managing Director – QAccounting Limited (www.qaccounting.com )

https://www.linkedin.com/in/gihope

Ian is a general practicing member of the Association of Chartered Certified Accountants with fellowship status (FCCA). He is also a member of the Certified General Accountants Association of Canada (CGA), and a member of Chartered Professional Accountants of Canada (CPA).

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Introduction

Often the term “self-employed” is used interchangeably with regards to these two options, particularly where the limited company is owned and managed by a single Director.  And while in some respects this is true, there are some fundamental differences between them and how they operate.

Strictly speaking, only a worker who operates as either a sole trader or a partnership is “self-employed”, and what this effectively means is that this worker is in business themselves and is also subject to tax themselves via the self-assessment system.

In contrast, while a limited company is also in business (as a separate legal entity), the directors and staff of the company are actually all “employees and employed” by the company.  Although some of them can also be business owners by virtue for also being shareholders.

But as the question: “Should I operate as a Sole Trader, or via a Limited Company?”, is very frequently asked by existing business owners and also people starting off in business for the first time, let’s consider these two structures in a lot more detail!

Administrative Differences

Limited Liability

This is probably the most significant difference between the two types of businesses!

Sole traders have unlimited personal liability for the debts of the business (if it is subject to legal challenge or your business fails).  This can be a very significant risk, because it means that your personal assets such as your house, car, and other belongings can be taken away from you if you owe money to creditors, which cannot be repaid.

Whereas for a limited company the liability of directors is normally limited to the value they invest in the business.  Which is the value of their share capital, or the value they have committed to guarantee (depending on the type of company used). Note however, that Directors can still be held personally liable in certain circumstances, for instance: if they trade whilst insolvent, fail to maintain proper books and records, or offer personal guarantees as part of conducting business.

Therefore, while using a Limited Company does offer much more protection than being self-employed it is still essential to fully understand your Responsibilities as the Director of a Limited Company.  If you would like to understand more about Director Responsibilities, please speak to one of our Accountants for advice, and we can supply a more detailed guide to assist you!

Sole Trader Businesses Do Not Have Shares

This is an important difference which impacts a number of key areas:

• Raising Finance Capital – It is not possible for people who are self-employed to sell shares in their business to raise (equity) finance. Nevertheless, you can still raise finance in other ways such as loans, crowd funding, etc.
• Transfer of Ownership – It is not possible to sell your self-employed business by selling shares, which can make selling this type of business in the future more difficult.
• Separation of Ownership and Control – It is possible to structure a limited company to achieve the separation of ownership (by the shareholder investors) and control (by the directors). This is not possible with a self-employed business.  Although you can still hire other staff, who you can delegate management responsibilities to.
• Extraction of Profits – All profits in a self-employed business are treated as income of the sole trader or partners in the tax year in which they are earned. In contrast, profits in a limited company are retained within the business by default, and may optionally be withdrawn when they have been declared by the directors as “dividends”, being paid to shareholders based on their percentage of share ownership.

Employed Vs Self-Employed

As discussed in the Introduction, a sole trader is “self-employed”, whereas in a limited company directors and staff are “employed”, and shareholders are only entitled to dividend investment income.

Where the director of a limited company is also a shareholder, then greater tax planning opportunities exists for extracting profits.

Confidentiality

There is no requirement to have a formalised legal agreement in place to operate as a sole trader.  In contrast partnerships typically have a Partnership Agreement in place to manage the relationships which exists between the partners, but there is no requirement to make this document publicly available.

Whereas in a limited company the Articles of Association (AOA) and Memorandum of Association (MOA) are public documents which can be reviewed by anyone at Companies House.  Although companies can optionally also have a Shareholder Agreements (similar in nature to a Partnership Agreement) in place which can remain private.

Other Differences

There are a number of other administration differences, but the main ones include the fact that sole traders and partnerships are not required to hold board meetings (as there are no directors), or shareholder meetings (as there are no shareholders), and they are not required to make decisions by resolution.

Taxation Differences

Considering each type of taxation in turn:

Income Tax

Sole traders and partnerships are taxed on a self-employed basis via a self-assessment personal tax return on the full “profits” made by the business during a tax year (which runs from 6^th April to the next 5^th April).

In contrast directors and shareholders are only assessable to Income tax in respect of either the salary or dividends that they withdraw from the business in the tax year.  As they are employees of the business, they will pay tax on their salary via the PAYE system.  And any dividends received will be taxed via a self-assessment personal tax return.

Due to these differences in treatment there are a number of tax planning opportunities which exist for limited companies that are not available if you are self-employed!  These include:

• The ability to retain funds within the business and withdraw these in the future when you may not be subject to higher rate tax.
• The ability to choose whether you extract funds as a salary or dividend, to ensure that the method by which you extract money is as tax efficient as possible by minimising your tax bill.
• Where your spouse or partner is not a higher rate taxpayer, it may be possible to employ them or grant them partial ownership in the business, so that they can also withdraw funds tax efficiently.

If you would like to understand more about how a Limited Company can be used to legally improve tax efficiency and increase the value of your take home pay, then please speak to one of our Accountants for some expert tax advice!

National Insurance Contributions (NIC)

Self-employed people need to account for and pay Class 4 NICs at 6% on the full “profits” made by the business during a tax year, over certain limits.

Directors and staff of a limited company as employees must pay Class 1 employee’s NICs at 8%, and the company itself must also pay Class 1 and Class1A employer’s NICs at 15% on director salaries and benefits.  Note however, that it is only your salary and benefits (e.g. company car, etc) that are subject to NIC, therefore any dividends you extract from the business are free from NIC!

For a more detailed understanding of National Insurance and how the Government’s recent changes to this tax may impact your business, please read my recent article entitled: “How will the UK Governments Recent Changes to Employers NI Impact my Business?”.

Corporation Tax

Only limited companies are required to pay Corporation Tax.

Given that Corporation Tax rates are now between 19% and 25%, and the rate is determined based on the profitability of the limited company, there is scope for a sole trader to be more tax efficient than a limited company in those circumstances where they cannot take advantage of the tax saving measures outlined in the Income Tax section (above).

Nevertheless, salaries, benefits, and employers’ national insurance are all deductible for the purposes of calculating Corporation Tax, which prevents the risk of double taxation.

VAT

The treatment of VAT is largely consistent between both sole traders and limited companies.

But crucially limited companies that qualify can take advantage of the Flat Rate VAT Scheme (FRVS), which can be more beneficial in those instances where a business incurs smaller values of expenses (as the VAT you pay on expenses reduces the overall value of VAT you need to pay to HMRC).

Can QAccounting Help Me?

Yes, we aim to be the UK’s Premier Online Accountancy and Tax Accountant, and we are here to help you every step of the way, whether you need to understand the rules in greater detail or need advice about next best steps.

Please give us a call, email us, or contact us ONLINE to speak to a member of our Accounting team without delay!