Which of the two structures is likely to give the best tax result?
Summary
How is a sole trader taxed? Pays income tax and class 4 NICS on his/hers taxable profits from trade. In addition, the individual pays Class 2 NICs.
How is companies taxed? Companies are liable to corporation tax on their profits. For financial year 2023 onwards, the main rate of corporation tax is 25%. However, the small profits rate of 19% applies where profits for the year are up to the lower limit, and marginal relief is given where profits are between the lower and upper limits, with the result that the effective rate of tax is between 19% and 25%.
Which gives the lower tax bill?
Based on profits of £60,000:
| sole trader after-tax receipt is £44,801 |
| company after-tax receipt is £47,850 |
The company results in more funds left in the business to invest.
However there are 2 layers of tax when considering a company, if the individual wants to withdraw profits from the company. They will want to be paid a salary which they will pay tax on and then income tax on dividends.
This is complicated , but still after calculations the company structure is better. (note. It should not be always assumed that setting up a company will be more beneficial , careful consideration needs to be undertaken.
The only way to know which is the better method of profit extraction is to work through the figures as everyone’s circumstances will be different, the following points are worth noting:
| * Level of income needed from the company. |
| * The individuals circumstances eg. Other income, age etc. |
| * Nature of the business and assets (allowances available like R&D tax relief) |
| * Initial losses and future growth. (loss relief more generous for sole trader) |
| * Cashflow- more time to pay tax on profits for the company. |
| Advantages of the company |
| *Limited Liability – protect personal assets. |
| * Perception – company preferred by stakeholders? |
| * Funding – issues shares; SEIS. |
| Advantages of the sole trader |
| * Simpler- easier to understand. |
| * Less paperwork means more time and lower cost. |
| * Information not publicly available. |
| * Rates of tax on dividends have increased. |
| * Tax-free dividend allowance has reduced and will fall again. |
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