When we first set up as a coach, we have many decisions to make. One of the first is how am I going to show up legally. Shall I trade as a sole trader, or shall I form a limited company?
This article is specifically aimed at a trader in United Kingdom as other countries such as the United States and European Countries have different rules as to how your legal status is defined.
The preferences are really down to you. As you would expect, there are advantages and disadvantages to both entities. This short article is written from a perspective of practicality and not as an accountant or auditor.
When faced with this decision when I set up my business, I opted for a limited company status. The process was quite simple and involved filling in a few online forms at the Companies House website, as well as a small financial transaction. The main reasons that I formed a limited company were
- my target market was mainly corporates. The limited company status appeared at that time to have more status. Interestingly, I also set up as VAT registered at the same time although that is beyond the scope of this discussion. I felt that this helped improved reputation.
- I wanted to separate out the liabilities of my business operation from my personal financial situation. I felt that this was just a cleaner option than having to run accounts as I would if I was a sole trader.
Details about a limited company
A limited liability company is a separate entity and a separate legal structure. When setting up a limited liability company, a number of shares are declared with a financial value (called Share Capital). This financial value is, with a few exceptions (such as negligence), the liability that a company can have. This means that the company offers protection in terms of its assets.
Some people do get confused when asked if they work for themselves. Legally we do not. We have a contract of employment to fulfil a role within the company, as a company director.
For this role, the company directors get remunerated with a salary on which national insurance and income tax is paid at the prevailing rate. The company also pays National Insurance contributions. As a limited company director, we have legal obligations that we need to perform. The assets of the business can never be considered as personal assets.
In all cases, there needs to be an annual declaration of the annual accounts to companies house and the Tax Office. In addition, there needs to be a confirmation statement (or annual return) filed of who the directors are as well as any person that has significant control (usually greater than 50% of share ownership). I would think of the person with significant control as the ultimate business owner as they hold the majority of shares.
If you also happen to own the shares of the company – then you can also benefit from a dividend of the profit. This profit is typically the business revenue less business expenses to run the business. Some feel that this is the most tax-efficient way of trading although this benefit has eroded over the past years.
The amount that is paid as a dividend has two tax implications
- the company has to pay corporation tax on the dividend declared in an annual corporation tax return.
- company directors have a tax liability if the dividend amount received is above the tax level. This is known as a dividend tax.
If your company does pay dividends to its shareholders (including yourself), you need to
- record in the minutes of a filed shareholder meeting that the board of directors have agreed to pay the dividend on the certain date in relation to the number of shares held
- issue a tax voucher to each shareholder as a record of the dividend payment.
Whilst neither of these are arduous, a failure to comply with these simple steps could result in penalties being issued by the tax office.
Details about a sole trader
The legal structure is different for a sole trader. As the name suggests, the sole trader is trading under their own name and therefore does not have a separate legal entity to consider. As an individual, the accountability resides with them, as does the relationship with the tax office for National Insurance and Income Tax payments. There is no corporation tax as a sole trader, as there is no corporation. Your personal finances are intertwined with the trading entity. Your tax situation for your trading is intertwined with your personal tax position and any tax-deductible expenses.
In both cases, careful financial records need to be kept and annual self-assessment tax returns need to be completed. I would also advise on Personal Liability and Public Liability Insurance from a reputable broker.
Although this is a short overview of sole trader vs limited company, you should always seek professional advice that can dig deeper into your personal situation and advise you on the detailed tax implications associated with your chosen business structure.