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nemesis nemesis is offline
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Join Date: Oct 2003
Location: Aberdeen
Posts: 361
sole trader or limited company?

Hi all

can someone educate me on the difference between a ltd company and a sole trader as regards tax.

i presume that as a sole trader i am liable to pay income tax on any profits going into the bank, is this correct?

also what sort of tax rate does a ltd company pay on say 100k in profits as an example

thanks
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brianabudabi brianabudabi is offline
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Join Date: Mar 2003
Posts: 125
Most important differance regardless of tax is that a LTD company has limited liability. That means if you get into difficulty the company is liable for the debts and not yourself - as long as you have traded legally.

The easiest way to think of the differance for tax reasons is that a LTD company is like another person a seperate legal entity in the eyes of the law.

This means that as a seperate entity it is liable to pay it's own kind of income tax - it just happens to be called Corporation Tax.

The company can pay you an income in two main ways

1 As a dividend - this is money that is paid to all the shareholders of the company in the case of small companies that might mean just you

2 It can pay you a wage like another employer might were the company has to pay your NI and income tax.

Usually if you operate through a LTD company and your not a tax evasion specialist you will pay slightly more tax - but you will have limited liabilty if your business fails. If you are expecting he sort of turnover that will see 100K profits I would say go LTD.

You will find the Corporation tax rates at the Inland Revenue web site
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James Smith's Avatar James Smith James Smith is offline
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Location: Abingdon, Oxfordshire
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Brians post, although pretty good about the legal seperation, is slightly misleading regarding the tax position for a limited company.

Taxes within a limited company are generally lower than for a sole trader, so long as you tax proper advice and dont pay yourself a salary greater than your personal allowance of 4615.

Taking the 100,000 example, a sole trader would pay 35,329 in taxes, a limited company with one director drawing minimum salary and dividends would pay 30,135 in 2003/4.

I wont go into all the math as it is quite complex, but there are real tax advantages in incorporating - if you do it right.

If you set up a limited company and pay yourself a 100k salary you will pay 48,000 in taxes - ie you have just wasted 18,000. (!!)

If you had (say) a husband and wife owning the limited company the taxes due would be even less.

For a comparison nearer to home for most folks, at 30,000 of profit, a limited company structure saves you around 3,800.

You can trust me on that - im an accountant!

Also you say in your original post,

"I presume that as a sole trader i am liable to pay income tax on any profits going into the bank, is this correct?"

This is quite so - you pay tax on your profit, that is the difference between how much you earn in the year, and your allowable expenses. Whether it is banked or not is not relevant.

Two other points:

1. It can be beneficial to run as a sole trader and incorporate after 6 months or a year (or longer), especially if you are not making much money. Without getting too technical, you can often sell the sole trader business to the limited company, and take some tax free income. (Again if you do it right)
2. You are not completely liability free. Directors have quite strict responsibilities- especially with respect to fraud and negligence. If you do become a ltd co, companies house send you a booklet explaining your responsibilities

The upshot of all of this is there is no clear answer as to whether incorporation is right for everyone there are tax advantages and some liability advantages, but downsides of additional paper work, higher fees, and other factors that should be taken into account.

I would suggest you get some help to decide from someone who knows all the ins and out, and can help you plan depending on your precise circumstances what the best thing to do is.
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nemesis nemesis is offline
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Join Date: Oct 2003
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thanks guys. most useful. i wish my profits were 100k at the moment but im hoping to change that :0
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Anthony Anthony is offline
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Join Date: May 2002
Posts: 23
Can I ask are dividends taxable?

and to what degree/ percentage?
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James Smith's Avatar James Smith James Smith is offline
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Anthony,

If you are a lower rate tax payer you pay no additional tax on dividends.

If you are a higher rate tax payer it gets more interesting, there is an effective 25% rate of tax on dividends, although you will see this displayed on the inland revenue website as 32.5%.

Look away now if you dont like numbers, but this is how it works:

Dividends come with a "notional" tax credit of 10%.

Ie say you recevie a 100 dividend in cash.

This comes with an (invisible) 11.11 tax credit.

As a higher rate tax payer you pay 32.5% on the gross dividend,

ie (100+11.11)*32.5% = 36.11

You can deduct the tax credit of 11.11

And you are left with 25 tax to pay.

Its rather odd but thats how it works.
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Anthony Anthony is offline
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very interesting my friend, thank you for sharing that with me
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Adam Adam is offline
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Join Date: Jun 2002
Location: Leighton Buzzard
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Avoid Tax and STUDENT Loans

A ltd company is great for me. Although I haven't made much money yet the tax works out great as James says and being VAT registered as well means that I have claimed back VAT on a load of expenses. Of course I now have to charge VAT which can be a downside!

James, I will look at your site and get you to be my accountant. I am very fond of the idea of tax minimisation (the legal term for tax evasion) and know what I need I just need some tidying up work done and some more questions answered.

If you are a limited company and pay yourself a small wage (James is it true that as a director you can earn less than minimum wage?) then you DO NOT PAY YOUR STUDENT LOANS BACK!!!!!!!!!!!

**The best way to fight the loans is not to pay legally**

James, what are the implications if you are in paid employment to go self employed through your own limited company and sell your services to your old employer? Tax would be lower but you then pay NI and don't get holiday pay and stuff I think.
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James Smith's Avatar James Smith James Smith is offline
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Adam,

Addressing your points:

Directors can earn less than the minimum wage, so long as you dont have a contract of employment.

Student loans - I have never thought of that one.

However is it "total income" ie including dividends they look or just "salary" ? You would need to check the wording of the loan agreement to be sure.

Now as for your last point regarding your current employer, this is when the alarm bells start to ring.

You used to be able to do just that - any many contractors did - but this loophole has been plugged up tight by "IR35" (Words to strike fear in the heart of many a subcontractor) This rather fierce piece of legislation prevents just this arrangement, and makes in ineffective to have your own service company.

There are a list of tests of whether you are self employed or employed here,

http://www.inlandrevenue.gov.uk/startingup/selfempl.htm

And more details on IR35 here:

http://www.inlandrevenue.gov.uk/ir35/index.htm

Finally I would be delighted if you took my services, but I do fear the above legislation may dampen the opportunities if IR35 applies in your case.

If you are not sure, please give me a ring to discus further.
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Adam Adam is offline
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I know all about IR35 (ba5tards at the IR!)

The Student loan is repayable when your GROSS INCOME is above 10,000 but I assumed that dividends were not income in that sense but I am sure there is another government sting in the tail there.

I have emailed you now regarding legitimate business.
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