What's the tax difference between being a sole trader/partnership and being a limited company?
Starting a new business and wondering which way would be more Tax efficient?
Then this guide is for you. In this 'Tip Sheet' we are only looking at the Tax angle but we do have another 'Tip Sheet' if you would like to know the commercial pros and cons. So please do call us if you have any questions or would like any other 'Tip Sheets'.
Sole trader/partnership
If you expect that you will make a loss during the first accounting period then it would be better to start out as either a sole trader or partnership.
The reason for this is that during the first 4 years of trading any losses can be carried back against the previous 3 years employment.
For Example:
Sarah sets up a printing business and due to the set up costs she knows there will be a loss in the first year. She starts trading 1st May 2005 and her accounts end 31st March 2006. During this period her accounts show a loss of £18,000.Before she set up the business she was in employment and had a salary of £60,000 a year. If we assume she had no income for the month of April 2002 then the £18,000 loss can be carried back into the previous tax year giving her a tax refund of £7,200 (40% tax).
We realise it is not always easy to know at the start whether or not you will make a loss but if there is any chance that you might then it would be better to start as a sole trader or partnership.
If after the first period you then make a profit a limited company can be formed.
And why would you want to do that? Read on.
Limited Liability Company
A limited company can help you to save tax.
For example:
You are making profits of £20,000 as a sole trader. You would be paying the following in tax and NI (under 2005/06 tax rules).
| Income Tax | £3070.30 |
| Class 2 NI | £109.20 |
| Class 4 NI | £1208.40 |
| TOTAL | £4389.90 |
If you made the same profits as a Limited company and took £7,500 as a salary and the remaining money as a dividend you would be paying the following in tax and NI (under 2005/06 tax rules).
| Income Tax | £322.30 |
| Class 2 NI | £287.32 |
| Employer's NI | £334.34 |
| Company tax | £2311.48 |
| TOTAL | £3255.44 |
This would save you £1134.46 in tax.
Contact us
This tip sheet is provided to you completely free of charge but if you would like further information please call us now to arrange a meeting. Print this voucher for a free initial meeting.
