One of the most common questions asked by the self-employed is whether to trade as a company or as an individual. The decision has implications for tax, legal and financial responsibilities, the amount of paperwork you will need to complete and how your peers will view you. There is no straightforward answer, because different legal structures suit different situations.
Once you have decided to be your own boss, you then need to choose the best structure for your business. This decision should be made at the outset, before you begin trading. The structure you choose can depend on your own personal situation and future plans, therefore the decision you make will have an impact on how you pay the relevant tax to HMRC. The most appropriate structure will depend on a number of factors, including the tax implications, the legal entity, ownership and liability. Most freelances choose to operate as a limited company simply because so many potential clients and agencies will only do business with individuals who operate in this way.
The downsides of the limited company are more rules and regulations, accountancy fees tend to be higher and the penalties for getting your paperwork wrong are greater. Plus you will have to pay corporation tax and you can’t just withdraw money from the business without formally recording it as a salary, dividend or loan. For freelances looking for a simpler approach, working as a sole trader is a relatively uncomplicated choice that will allow you to focus fully on the important things – getting work and then delivering it to a high standard.
To operate as a sole trader, simply contact HMRC and register for self assessment. This can be done online and should be done by 5th October, following the end of the tax year that you are sending a return for. You will need to enter your earnings every year, and the tax will be calculated for you. To form a limited company, it’s a little more complicated. You will need to register with Companies House and receive a certificate of incorporation which confirms your company legally exists and shows the company number and date of formation. There are restrictions on company names, and who can act as a director and as company secretary.
Whichever path you choose, it’s important to understand that your decision isn’t final. It is always possible to change at a later date. Advantages and disadvantages of a Limited Company
• Higher take home pay – You’ll typically take home around 75% – 80% of your contract by working through your own limited company.
• Claim on a wider range of expenses – Anything that is solely classed as a business cost can be claimed back on expenses. Trading through a Limited company means you can claim on a wider range of expenses such as accountancy fees, equipment, software, phones, travel, Internet and much more.
• Entitled to the Flat Rate VAT scheme – The Flat Rate VAT scheme can generate thousands of pounds of extra profit a year
• Personal assets are covered – As a non-limited business, personal assets can be at risk if the business fails, but this is not the case for a limited company. As the shareholder you can not be held personally liable for the debts of a limited company, meaning your personal assets are not at risk.
• Complete Control of your Business – You keep complete control of your financial affairs meaning you do not have to risk your money with any third party administrator or umbrella company.
• Greater opportunity for tax planning than PAYE Umbrella – It goes without saying that working through your own limited company is more financially rewarding, which is only fair bearing in mind the extra responsibilities and loss of full time employment benefit.
• Company given more credibility – Operating as a limited company often gives suppliers and customers a sense of confidence in a business and quite often other companies prefer not to deal with non-limited businesses.
• Protection of your company name…even if you are not contracting. Once your proposed company name is registered as a limited company, the name is protected by law and no one else is allowed to use it, waiting to register your company could mean you lose the name you had initially wished to trade under. Disadvantages of a Limited Company
• A certain amount of paperwork involved – As mentioned above, there is about 15-20 minutes of administration work required per month, not much more than that of an Umbrella Company.
• Accounts need to be filed every year – You have to file your accounts at Companies House each year, which will be on public record however your accountant will help with this. You will also have to file accounts, company tax and corporation tax calculations with HM Revenue and Customs every year
• Costly if contracting for a short period of time – Can be costly if you have a short term contract (anything less than a couple of months but it does depend on your daily contract amount) then decide to go back to permanent employment as you will still be required to submit end of year accounts.