self employed or limited company

self employed or limited company


Starting your own business is an exciting time. In getting it started, you will undoubtedly have loads of questions. One of the questions I get asked the most is ‘is it better to work as a self-employed person or set up my own limited company?’

Read more

There is no quick answer, as every person’s situation is different. In deciding what is right for you, there are various things to consider.

Being self-employed means you are offering your services or engaging in your trade as yourself. There is no separation between you and the business. A person operating in this way is also known as a ‘sole trader’.

When starting up, people often find this the easiest place to start, as it’s very easy to set up. You merely have to register with HMRC as being self-employed within 3 months of starting your business and you’re away.

You will also have to complete a self-assessment tax return by 31 January each year, covering the period to 5 April. If you have only had income from employment before, this may be a new administrative task. If you have already been completing tax returns, the tax profits of your business get added into the same income tax return.

How is that different from running a limited company?

When your business is in a limited company, it is the company that runs the business. You are an employee and/or director of the company – so the business is a separate thing from you.

There is more administration in running a limited company, you have to prepare and file annual accounts and an annual return with Companies House. These documents are in the public domain, so anyone can request a copy of them. A company will also have its own tax return that has to be prepared and lodged with HMRC.

When you pay yourself, there are various ways to do it and all require record-keeping. You will almost certainly need to operate a payroll, even if you are the only employee in the business.

The reality is that the extra administration is not really a burden for most people, but it does come at an additional cost – and if the business does not earn much income, it is certainly a factor that should be considered.

What are the pros and cons of each?

Leaving tax to the side for a minute, there are pros and cons for each type of set up.

Self-employment is easy to set up and run, and generally has lower administrative costs than running a company. However, if things go wrong for the business there is generally little protection for the owner. Because there is no separation between person and business, any debts of the business are the personal debts of the business owner. This means that any personal assets, such as the family home, can be at risk if the debt collectors come calling. Raising finance for sole-trader businesses can also be more difficult.

On the other hand, a company has limited liability. That means that any debts of the company can only be met by the assets of the company. Except in rare circumstances, the personal assets of the director/shareholder are protected. The trade-off for this is higher administration costs and the fact that there is less privacy, in that the accounts of the company become public records.

One of the other benefits of running a company is that it can be seen as ‘more professional’ when dealing with customers and clients, and can give the impression on a business card or website that it has more scale than a person running a business on their own from their home office (even if that is what you really are doing!).

Yes, but what about tax?

There are advantages to both self-employment and limited companies.

Generally limited companies can be more tax advantageous, for the following reasons:

  • By structuring the way you pay yourself you can avoid most national insurance payments (up to 9% of business profits), whereas this is unavoidable as a sole trader
  • If you have a bumper year, you can keep profits inside the company and take them as remuneration in the following tax year so as to avoid hitting the higher tax rate (40%) or the additional tax rate (45%). With self-employment, you are taxed in the year that the business makes a profit.
  • By having an employee (i.e. you), a company can take advantage of the current £2,000 employment allowance, which refunds employer national insurance contributions up to this amount. In a self-employed business you can’t be an employee (you can’t pay yourself).

Companies don’t have it all their own way, though. In relation to sole-trader businesses:

  • It can claim a proportion of the home office costs without supplying invoice records, such as mortgage interest, rates, light and heat. A company can claim £4 per week without an invoice, or it can invoice the shareholder for a proportion of home costs – but not mortgage interest or council tax.
  • The sole trader can make use of £10,000 (for the 2014/15 tax year) tax free amount, whereas a company will pay 20% on all of its profits
  • If a sole-trader business makes losses in a year, these can be offset against other income – such as rental income, investment income or other employment income. A company can offset its own losses, but you can’t use these as a shareholder against your other income.

Which of the above matters more to you will depend on your personal circumstances, how much money you expect your business to make and what level of administration you are comfortable with.

Once you have made a choice as to how you want to operate, you don’t actually have to stick with your decision. You are able to convert your business from sole-trader to company, and back again, if you wish to. This will usually come at a bit of a cost of administration, but it’s important to know that this is always an option for you.

Anything else to consider?

Some people look into running a limited company for the first time as they are looking to do contract work and want to do so, or are asked to do so, through a limited company.

There is a risk here that you may run into what are known as the “IR35” rules. These rules place additional taxes on people who provide their personal services through a company, and HMRC finds that the only reason for using the company is to avoid taxes as an employee.

This area of tax is complicated. If you are in this situation you should seek professional advice at your earliest convenience.

Contact Us

Often it will help discussing your situation with a tax professional to help you decide what is right for you. Contact us to schedule an obligation free 1 hour appointment to see how we can help you.