Timing Considerations for Backdated Payments

Key Tax and Legal Differences

Starting a business is an exciting venture, but it also involves many decisions, including choosing the right business structure. In the UK, two primary options are operating as a sole trader or partnership or setting up a limited company. Each structure has advantages and considerations, and understanding the differences is crucial in making an informed decision that aligns with your goals and circumstances.

Below is a comparative table summarising the key tax and legal differences between operating as a sole trader or partnership and setting up a limited company as a director/shareholder:

AspectSole Trader or PartnershipLimited Company: Director & Shareholder
Legal EntityYou are the business.The business is a separate legal entity to its shareholders and directors.
OwnershipYou are the owner.You are a shareholder; you hold all or part of the company’s share capital.
LiabilityPersonally liable for business debts.Limited liability protection; personal assets protected.
TaxationPay Income Tax and NICs on trading profits.The company pays Corporation Tax on profits; shareholders are taxed on income drawn.
Loss OffsetCan offset trading losses against other income.The company can offset trading losses against its other income.
Profit ExtractionWithdraw profits with no tax effect.Taxed on income withdrawn (dividends or earnings).
BorrowingFree to borrow from the business account.Borrowing by directors permitted; tax implications.
PensionPersonal Pension only.Various pension schemes are available for directors/shareholders.
InsolvencyPersonally liable for business debts.Limited liability: the director may be held accountable if trading while insolvent.
Making Tax Digital (MTD)From April 2022, all VAT-registered unincorporated businesses must report under MTD for VAT and use MVD ‘functional compatible software’ Making Tax Digital for VAT.Same requirements as for Sole Trader.
AccountsThere is no requirement unless within MTD for VAT.Must prepare annual accounts; file with Companies House.
Selling the BusinessTaxed on any gain under Capital Gains Tax rules.Double tax charge on shareholders; company pays Corporation Tax on profit.
Business ContinuityBusiness ceases upon death; succession planning challenges.The company continues; shares may qualify for Business Property Relief for IHT.
Paying YourselfWithdraw any amount of profits.Salary is subject to PAYE and NICs; restrictions apply.
ExpensesTax relief for business-related expenses.The company obtains tax relief; private expenses may be treated as earnings or distributions.
Cars and FuelCapital allowances for cars disallow private use proportion.Full capital allowances; special rules for fuel.
Mobile PhonesSubject to private use restrictions.Provided tax-free if the contract is in the company’s name.
ComputersCapital allowances are available; add-back is for private use.Provided without tax consequences if used for the role.
Tax-Free BenefitsNot applicable to self-employed.Various tax-free benefits are available for employees.
Working from HomeClaim deduction for home office expenses.Reimbursement for certain expenses by the company.
Charging Rent for Use of HomeYou cannot charge rent to oneself.A license agreement can be set up between the director and the company.

This comparison highlights the significant differences in legal structure, taxation, liability, and other aspects between operating as a sole trader or partnership and establishing a limited company. It’s essential to consider these factors carefully and seek professional advice to determine the most suitable business structure for your needs and circumstances.