Chartered accountant Elaine Clark of CheapAccounting.co.uk provides answers to key questions about when to turn a sole trader business into a company
Why would I form a company (ie incorporate) rather than simply register as self-employed?
The two main reasons are limited liability and it can be more tax-efficient. Limited liability basically means the debts are the company’s – not yours. As a sole trader, you are personally liable. Moreover, as a limited company director, you take money out of the business through a combination of a small salary and dividends.
Crucially, you do not pay income tax on dividends up to the dividend allowance threshold of £2,000 from April 2018; although this has decreased from £5,000 in the previous two tax years. Dividend income over the dividend allowance threshold is taxed at the rate applicable to your income tax band (7.5% basic rate, 32.5% higher rate or 38.1% for additional rate tax payers). There is no national insurance paid on any dividend income. So this means that you could pay less in tax by using a mixture of dividends and salary.
Some think that being a limited company involves paying much higher accountancy fees, but this isn’t always the case.
Is there a risk I’ll pay more tax if I stay as a sole trader?
There is, that’s why I recommend that all sole traders carry out a ‘tax fitness check’ at least once a year, to see what your finances look like compared to if your business was a limited company.
Are there any other reasons why a sole trader might incorporate?
Customer perception. Not all, but some customers, possibly larger businesses, prefer to buy from companies. To an extent, being a private limited company might make you more credible to potential customers, partners or investors. Some people also believe being a director of a limited company improves their standing, it’s a prestige thing...
What does the incorporation process involve?
It’s very easy and can take less than 24 hours. You can do it yourself by completing some paperwork and filing it at Companies House with your registration fee which is just £15. However, for a small fee, a formation agency can take care of the whole process for you. A word of caution, though – don’t get sucked into buying a “deluxe” incorporation package. You won’t need most of the added extras. Also think carefully about share capital. Avoid setting up large amounts of share capital, such as 1,000 shares at £1, because you’ll have to put £1,000 into the business and that will be tied up. You can start a company with as little as one share at £1 and one director.
In what circumstances might it be wise to turn my limited company into a sole trader business?
If your profits decrease significantly, being a sole trader might be more tax efficient, but because you will then be liable, you need to think carefully about how much debt your sole trader business is likely to build up. You may think that being a sole trader will involve less tax admin and form-filling. To an extent it probably will, but bear in mind that you do still need to file accounts and tax returns, so you will still have legal responsibilities.
How do I close my company and re-register as a sole trader business?
Make sure your company accounts and tax returns are up to date. Once these are filed there’s a formal process to follow. It’s not difficult, but it will take some time – it’s not quick. Assuming that the company is debt-free, you complete a DS01 form, which can be downloaded from the Companies House website. It’s easy to complete and there’s a £10 fee. To close a company down:
- It must not have traded for the last three months.
- Its name must not have changed within the last three months.
- It must not be subject to any legal proceedings, current or proposed.
- You must not have made a disposal for value of property or rights.
The trading name can be carried over into the new business, obviously, minus the word ‘limited’. If your company is in debt and you want to close it down, there are separate rules. I’d suggest seeking advice from a qualified accountant. You can set up a new sole trader business simply by calling the HMRC hotline on 0300 200 3504 or by registering online.
How common a problem is owners sticking with the original legal structure of their business, even though they could be paying more tax as a result?
It’s very common. I call it the “cost of complacency”. I wonder if people realise just how much is coming out of their pockets as a result? Some people seek advice from friends, family or even online forums. While these can be good sources for some business topics, when it comes to tax you really should seek advice from a qualified accountant. They will be able to help you decide which structure is most tax-efficient now and in the future.
Written by Elaine Clark of Cheap Accounting.