The issue of whether to run your business as a company or a sole trader is an important one. In this factsheet, we summarise the potential benefits available from operating as a company.
Is trading as a limited company the most beneficial option?
In our view it can be beneficial, in tax terms, to trade as a limited company as there can be annual tax savings. However, this will depend entirely on the individual circumstances of the Directors and the profitability of the business.
The examples below give an indication of the 2021/22 tax savings that may be achievable for sole traders.
|Tax and NIC Payable:|
|As a company||£9,891||£30,530|
The extent of the savings is dependent on the precise circumstances of the tax position and may be more or less than the above figures. The examples are computed on the basis that the individual:
- has no other sources of income
- is a Scottish taxpayer
- takes a salary of £8,840 from the company with the balance (after corporation tax) paid out as a dividend and there are no reserves left in the company
Income Tax for sole traders in Scotland
Sole traders in Scotland will have their profits taxed under the Scottish rates of income tax. Other forms of income such as interest or dividends will be taxed at the rates set by the UK government. The income tax rates in Scotland are as follows:
|Band||Taxable Income||Scottish Tax Rate|
|Personal Allowance||Up to £12,570||0%|
|Starter Rate||£12,571 to £14,667||19%|
|Basic Rate||£14,668 to £25,296||20%|
|Intermediate Rate||£25,297 to £43,662||21%|
|Higher Rate||£43,663 to £150,000||41%|
|Top Rate||over £150,000||46%|
Rate of corporation tax
Profits are taxed at 19%. (Increasing to 25% for companies with profits of £250,000 or more from April 2023)
Taxation of dividends
The cash dividend received is the gross amount potentially subject to tax. The rates of tax on dividend income are 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
A dividend tax allowance taxes the first £2,000 of dividends received in a tax year at 0%.
The rate of employees’ national insurance contributions (NICs) is 12% on earnings in excess of the primary threshold (£9,568 for 2021/22) up to the Upper earnings limit. The rate reduces to 2% on all earnings over the NIC upper earnings limit (£50,270 for 2021/22). The rate of NICs for the self-employed is 9%, on profits above £9,568, reducing to 2% on profits above £50,270 for 2021/22.
Employers pay National Insurance at 13.8% on salary in excess of the Secondary threshold (£8,840 for 2021/22), so extraction of a salary of £8,840 will not give rise to employee or employer NIC contributions Employer’s NIC is also payable on benefits in kind provided to employees.
Dividends are not subject to National Insurance, making dividends much more tax efficient than salary when the amount being drawn from the company exceeds the lower NIC threshold.
As an employee/director of the company, it should be possible for the company to make pension contributions (subject to limits) to a registered fund irrespective of the salary level, provided the salary level is justifiable based on the work the individual is carrying out for the company. Companies receive a corporation tax deduction for the net contribution made by the company, this makes employer contribution a very tax efficient way to extract funds from a company. For the 2021/22 tax year, the corporation tax rate is 19% so for the company to make a contribution of £100 it will only cost £81 due to the tax relief in the company.
Pension contributions are deemed to be private expenses for sole traders and partners. Sole Traders making private pension contributions receive relief through the extension of their basic rate bands by the gross amount of the contribution. There contribution is topped up by 25% by HMRC and added to their pension.
Incorporation of a sole trader business
Incorporating your existing business will involve transferring at least some of your assets (most significantly goodwill) from your sole trade or partnership into your new company in exchange for shares. The transfer of goodwill may create a capital gain although there is a mechanism for deferring the gain until any later sale of the company if the business is transferred in exchange for shares in the company.
A company normally provides limited liability. If a shareholder’s shares are fully paid up, then they cannot normally be required to invest any more in the company. This means that your risk of loss is limited to however much you have paid for your shares. However, banks often require personal guarantees from the directors for borrowings. The advantage of limited liability will generally apply in respect of liabilities to other creditors.
A limited company will need to prepare annual accounts in a format dictated by the Companies Act and, in certain circumstances, the accounts need to be audited by a registered auditor.
A company will also be required to submit an annual corporation tax return to HMRC to report and pay the tax due. If the shareholders of the company are to be paid a salary the company will have to run a payroll with monthly reporting requirements.
Employee share ownership
Employee shares are often a useful way of recruiting, incentivising and retaining employees. In addition, companies will usually get a corporation tax deduction where employees get shares at a discount to their market value.
There are a number of ways in which employee share ownership can be achieved and we have noted below two of these ways, for your consideration. For example:
A transfer of shares issued on incorporation
You may wish to gift, sell or have the company issue some shares to key members of staff following incorporation. However, where an employee/director receives shares at a discount, they will be subject to income tax (and potentially NIC) on the discount. A share valuation would therefore be required to quantify the value at the time of gift or issue. A gift is a chargeable disposal for Capital Gains Tax (CGT) for the transferor, with deemed disposal proceeds equal to market value.
It should be possible for the transferor to claim relief under the gift holdover rules in relation to the gift of shares. However, it will still be necessary to review the tax consequences of the gift at an undervalue in respect of the employee/director. Any transfer of shares to employees (even a sale at market value) must be notified to HMRC by 6 July following the tax year it takes place.
Consideration can be given to issuing shares with different rights to new employees/directors, perhaps to give them different income or voting entitlements, however it will be necessary to obtain a share valuation to quantify the value of the different share classes.
EMI share options
These are very popular schemes for smaller, entrepreneurial trading companies. They are tax-efficient for the employee, and can, if desired, be offered to key individuals. Employees are granted with options to acquire shares at a later date. The terms of the exercise of the options can be designed to maximise employee retention and suit the business.
On exercise, provided the price per share paid by the employee is not less than the market value at date of grant, there are no income tax or NIC consequences for the employee – hence any increase in value between the date of grant and exercise of the option is not subject to income tax / NIC. Instead, the employee would pay CGT at rates of as low as 10% on disposal.
The valuable tax breaks EMI schemes offer do mean that there are tax rules and administration requirements to comply with; share valuations are required before options are granted. There are also obviously professional fees associated with the set-up and running of EMI schemes, which will be much higher than the option noted above. Additionally, a share valuation will be required.
EMI is not available to employees working fewer than 25 hours a week (or less than 75% of their paid working time, if less) for the company; nor is it available where the share award is to recognise past efforts, as EMI options are intended to help with staff incentivisation and retention.
In order to decide which form of share scheme suits you best, we can discuss the circumstances of the new company and your commercial requirements. We can also advise on the tax implications and compliance requirements.
Get in touch
If you are interested in starting to trade as a limited liability company and would like to find out more, please contact one of our dedicated specialists listed below.