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10 February 2021

Starting your own Business | What you need to know

Frequently Asked Business Question:

I have worked as an Engineer with my employer for the last 15 years and now considering starting my own business as a consultant.  I have done some research and I am confused as to whether I should be self-employed or form a limited company. Can you explain the difference?

Top Tip:

Moving from the security of a job and a steady wage every month can be daunting. Unless you have other sources of income, generally, employees don’t have to worry about completing an income tax return and paying tax separately to HM Revenue & Customs because it is all collected through the PAYE system operated by your employer.

When you start your own business, whether it be through self-employment or operating a limited company, you will be responsible for paying the correct amount of tax on any income you earn.  There are key differences between the tax that is paid by a self-employed individual and tax paid by a company. There are also key differences between operating a sole-trader business and a limited company.

A self-employed individual who owns a sole-trader business is essentially the “same person”.  The individual would have sole responsibility for the business, its debts, employees, customers, etc.  If the business gets into difficulty, the individual’s personal assets could be at risk.  Any income extracted from the business would be treated as drawings.  The profits from the business would be from part of the individual’s sources of income and included on their self-assessment income tax return and taxed accordingly.

Each individual can earn a certain amount of income before they pay tax, this is known as the personal allowance and is currently £12,500.  Any earned income in excess of the personal allowance, is, broadly speaking,  taxed at 20% up to £50,000, 40% from £50,0001 to £150,000, and 45% on income over £150,000.  In addition to income tax, Class 4 and Class 2 National Insurance contributions would also be due.  Class 4 NIC is paid on profits in excess of £9,500 at two different rates, 9% on profits between £9,501 to £50,000 and 2% on profits over £50,000.  Class 2 NIC is payable at a flat rate of £3.05 per week.

In contrast to a sole-trader business, a limited company is a separate legal entity and would be deemed to be a business in its own right.  The owner of the company would be classed as a share-holder and in most cases, for owner-managed businesses, would also be a director of the company.  The directors of the company are responsible for the day to day running of the company and decision making.  The company will have sole responsibility for the business, its debts, employees, customers, etc. and if the business gets into difficulty, the individual’s personal assets may not be at risk due to “limited liability”.

A company pays corporation tax at a rate of 19% (current rate) on its total profits. This rate is significantly lower than the income tax rates for self-employed individuals.  However, it is important to note, that the share-holder, the owner of the business, would have to extract income from the company, for example, a salary, which would be subject to income tax.  Therefore, essentially, the same income could be taxed twice.  Share-holders can also extract a dividend from the company at slightly reduced income tax rates but there are a number of areas to be considered and careful planning would be required.

A limited company is more costly to operate from an administration point of view, as statutory accounts are required which need to be filed at Companies House and an extra tax return is required. The decision to trade as a self-employed individual or through a limited company should not be based on tax savings alone and it is important to consider both the tax and commercial reasons for each option.

When starting to trade, there are other taxes that also need to be considered.  If you are employing staff, your business entity would need to register as an employer and operate PAYE. Registration for VAT should also be considered either compulsory or voluntary registration. Other areas that you may also need to obtain advice on would be the type of accounting package to use, book-keeping and the availability of any grant supports for new start-ups.

Starting your own business, as previously noted, can be a daunting task, however, it can also be exciting as you embark on your new venture.  It is important that you engage the services of an accountant who will grow with your business and help you reach your goals and aspirations.

For more information and/or assistance, please do not hesitate to contact me at the email address below or phone our Tax Team

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The advice in this column is specific to the facts surrounding the questions posed.  Neither FPM nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.

Contact Siobhan

Siobhan McCreesh / Associate Tax Director

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