Would it be best to set up as a Sole Trader or a Private Limited Company?

By Andrew Crawford

Introduction

This has been a very popular question recently especially for all you Entrepreneurial type Fitpros wanting to branch out on your own.

So instead of just giving you my opinion in a couple of paragraphs on what I believe you should do, I thought it best to summarise other considerations you will find useful in coming to a decision for your business structure.

To draw on a conclusion without looking at other aspects would not be doing you a service. Here are a few important areas you need to know or be aware of when deciding.

Oh….and where I use the word ‘Self-Employed’ I also mean ‘Sole Trader’ as they are interchangeable.

OK are you ready?…..well let’

1. Set-Up

To start with, the initial setting up for both options follows different paths.

Sole Trader: A simple phone call or the completion of a downloadable form will enable you to register as self-employed. Thereafter you will be known as a Sole Trader. There is no charge.

Limited Company: A few years ago it was time constraining to set up a company. Nowadays a Company Formation company can set up a Limited Company within hours. Expect to pay anything from £30 – £100.

2. Debts – Limitation of Liability

Sole Trader: You will be personally liable for all the debts of your business. Once you become self-employed there is no distinction between your business money and your personal money. Therefore all business debts are the personal responsibility of you the sole trader. You would have heard this referred to as unlimited liability. Can they come after your home if the debts you owe have not been paid? Yes indeed, if they have to.

Limited Company:  The advantage of a private limited company is that the company is a separate corporate body and liability for payment of debts stops with the company. Therefore it has limited liability. You, as the owner and or shareholder, are not personally liable. The directors are only liable if they continue to trade and incur liabilities after it becomes apparent that the Limited Company is insolvent, meaning that it cannot meet its debts as they fall due.

3. Taxes

Sole Trader: Sole Traders pays Income Tax. A sole trader receives a £9,440 personal allowance and pays basic rate tax of 20 per cent on the next £32,010 of profits up to the next threshold limit then 40 per cent tax on profits between £32,011 – £150,000 thereafter 45% on profits over £150,000.

In addition to this tax, there is also Class 4 National Insurance which is 9 per cent on profits between £7,355 – £41,450 plus 2 per cent on profits over £41,450.

Also you need to pay Class 2 National Insurance of £2.70 per week.

Oh….not forgetting advanced payment of tax called ‘Payment on Account’ once your tax and NI is over £1,000 in the year.

Limited Companies:  Companies pay Corporation Tax. For profits falling between £0 – £300,000 the Corporation Tax rate is 20 per cent. For profits between £300,001 –  £1,500,000 there is a tax rate called ‘Marginal Rate’ tax of 23.75 per cent then it is 23 per cent for profits exceeding £1,500,000.

No class 4 NI no Payment on Account…….!!

4. Sole Trader accounts and Limited Company accounts

Sole Trader: Sole trader  accounts can be quite simple as a formal accounting system is not required and can be reduced to simple lists of income and expenditure supported by documentary evidence of sales and purchase invoices, effectively single entry bookkeeping. From this you can produce a Profit & Loss account. Producing a balance sheet is optional.

Due to the simplicity an Accountant may not be required saving you some costs.

Limited Company: Limited Company accounts have to use double entry bookkeeping to produce the year end accounts including a balance sheet with statutory notes and statements. Unless accounting software is employed to produce the company accounts in this format then accounting knowledge is required and an Accountant’s fee may well be in the region of £600 to £1,200.

An Accountant is not essential for a small Private Limited company but is the normal approach and costs can be offset to add to the tax advantages.

5. Additional financial considerations

Sole Trader

Rule:  To be eligible for deduction, expenditure has to be ’Wholly & Exclusively’ incurred for the purpose of your business.

Status: Being self-employed you will be the owner or proprietor of the business. Your drawings (wages/salary) are not deductible expenses.

Pensions: Pension contributions of a sole trader are personal and while may be deducted from the personal income liability do not form part of the basic accounts.

Use of a car: The sole trader basic accounts would include  only the business proportion of the vehicle running costs or the mileage allowance.

Charging rent for use of home: As a sole trader you cannot charge yourself rent.

Working from home: If you have an office at home you will be able to claim a deduction for mortgage interest, rates and light and heat and any other expenditure you have incurred in your business.

Mobile phones: Mobile phones will be subject to private use so a tax add-back is expected on your tax return.

Selling the business: When the business or assets used in it are sold, you are personally taxed on any gain under the Capital Gains Tax (CGT) rules.

Death: When you die your business ceases. You can pass all or part of it down to the next generation.

Limited Company

Rule: To be eligible for deduction, expenditure has to be ’Wholly & Exclusively & Necessarily’ incurred for the purpose of your business a much stricter rule.

Status: The Director, usually you, is an employee of the Private Limited Company.  Therefore, your wages or salary can be deducted as an expense.

Pensions: The pension costs including any company contribution to a pension scheme by a private limited company is a deductible business expense as an employee cost.

Use of a car: Using a car for business purposes may have an impact. If that vehicle is used by you as a Director then you are receiving a taxable benefit potentially resulting in a higher tax burden depending upon the type of vehicle.

An alternative you may consider is to have the company vehicle privately owned by you then you can claim mileage allowances rather than vehicle running costs.

Charging rent for use of home:  As a Director you may set up a licence between you and your company to rent an office (or other space) in your home or outbuildings. This will enable you to recharge a proportion of mortgage interest and council tax.

You will need to declare this as income and prepare rental accounts.

Working from home: You can claim £4 per week without receipts for home expenses.

Alternatively, the company can reimburse you for light and heat, but not mortgage interest or council tax.

Mobile phones: Mobile phones can be provided if the contract is in the company’s name, tax free. Only one mobile per household.

Selling the business:  When the business or the assets used in it are sold, there is a double tax charge on shareholders. The company pays corporation tax on any profit that it makes on disposal. The shareholders are taxed on the distribution of the proceeds.

  • It may often be more efficient to sell the shares in a company, rather than its trade or business, or individual assets.
  • Company shares can be gifted.
  • Providing you own more than 5% of a trading company, a disposal with gains of up to £10 million may qualify for CGT Entrepreneurs’ Relief.

Death: When you die the company lives on: it is a separate legal entity.

The company’s shares will qualify for Business Property Relief (BPR) for IHT purposes, providing the company is engaged in trade and its activities are not wholly mainly investment activities.

A private limited company advantages consist of being able to claim such expenses as valid business expenses whilst abiding by the ‘Rules’ as stated above, which would not be claimable in the sole trader basic accounts as they would be treated as personal not business expenses.

6. Administration, Management and Other Considerations

Sole Trader

A sole trader basically pleases themselves with regard to the administration and management of the business.

Accounts: There is no need to file accounts. Instead a Tax Return is submitted to the HMRC each year.

Losses: You can offset losses against other income in the year of loss and carry back losses to prior years.

Brand: Your brand name as a sole trader can be anything you wish however you must ensure not to breach trademark or copyright rules. You can trade under any name as long as you state it in documents such as invoices, for instance, you may have the name “Swift Fitness trading as Personal Training and More” which will need to be stated on all documents related to the business. You do not have to worry about registering to a significant body or organisation if you are trading as a sole trader. The problem comes with protecting your business name. As registering a trademark can be expensive, you can use your business name in situations such as for bank accounts or as an advert in the yellow pages to prove you have been using the name before others, if any problems arise.

Exit Strategy:  This can be a difficult task for a sole trader as typically the equipment used is owned by you personally, and many elements of the business will be tied to their specific identity.

Limited Company

A company Director is responsible for adhering to company administration according to Statutory Regulations in regard to both the limited company accounts, statutory books and management as stated in the Articles of Association. The duties of a Director are more formal than a sole trader and the company is governed by the Companies Act

Accounts:  You must file an Annual Return and Accounts with the Registrar of Companies each year. These are public documentation so anyone can order your company information.

You will also need to submit a Company Tax Return and Tax Computations with full accounts to HMRC on an annual basis.

Losses: You can only carry forward losses and offset them against future income.

Brand: Once you register with Companies House you will have ownership of your specific business name which no one else can use. Even if you keep the name dormant for a long period of time, you will still have the rights to the brand name so there is no rush to start trading.

Exit Strategy: As a Limited Company is its own legal entity, should you wish to hang up your hat, you can sell your entire business – clients, equipment and all.

Business Standing: Forming a private limited company is an indication that your business is both serious, has a long term objective and is correctly managed. This psychological perception can increase the business standing of your business.

In addition funding requirements are more likely to be met as the lender to a sole trader has to consider the absence of a balance sheet statement in the basic accounts and the financial influences personally affecting the sole trader.

A private limited company advantages concern the published financial statements, protection of the financial position from personal influences and the option of increasing security by virtue of asking directors to provide additional personal guarantees.

A private limited company advantages over Sole traders also extends to long term finance. Companies tend to retain more funds within the business to meet future financial commitments which aids year on year growth, a more sustainable business and medium term profits growth over a sole trader.

7. Extraction of Profit

Sole Trader: As profit is made, it is taxed with additional NI being applied. There are not multiple routes in which to extract the profit in a tax efficient manner.    

Limited Companies: There are multiple routes in which to extract profits in a tax efficient manner. These include:

Salary, Bonus, Dividends, Loans, Interest, Pensions, Free Accommodation, Childcare and Royalties

For instance, in addition to taking a salary, you can also take dividends.

Dividends are taxed at 10 per cent on total income up to the higher threshold and 32.5 per cent above thereafter 37.5 per cent. The dividend is a distribution of company profit after corporation tax has been deducted and so you as the shareholder also receive a dividend tax credit from the Private Limited company of 10 per cent.

There are significant private limited company advantages regarding tax liability compared to a sole trader where net income is below the upper earnings threshold.

People love this way because if a salary is taken the rest can be taken in dividends. A private limited company would pay it’s 20 per cent corporation tax, after deducting the salary from net taxable profit and the shareholder would pay no income tax.

The advantages increase where net taxable profit is above the self employment upper earnings limit as money can be left in the business and therefore only subject to the 22 per cent corporation tax rate thereby avoiding the sole trader 40 per cent tax rate. Another possibility is to distribute the shares among family members to reduce the risk of 40 per cent tax.

Conclusion –  So…..Which One is BEST?

Please click here to view the conclusion: fitnessindustryaccountants.com

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