October 26th, 2012 / Insight posted in

Ltd status can reduce tax bill

MT writes: I run a small business providing services on a part-time basis to the domestic market. My turnover is almost £70,000 and I am registered as a sole trader. I also have a full-time job that pays more than £30,000 a year, an income that is taxed under PAYE. I am beginning to wonder whether, for tax purposes, I should register my company as a limited liability company. Would that reduce my tax bill?

You should consider all the implications for your business and not make a decision based purely on tax. Incorporation is a big step with pros and cons. It will provide some protection for your personal assets, though this is of limited value in your trade. On the other hand, you must file annual accounts at Companies House within 10 months of each year end. Although your sales are below the threshold for an audit, the costs of your statutory accounts would still increase. The tax advantages depend on your circumstances. Sole-trader status still has some tax advantages if you draw out all your profits from the business. Employer´s national insurance (NI) of 12.2% is levied on directors´ pay but not on partners´ drawings. Therefore, if you were to withdraw the profits as a salary there would be an extra NI liability. Dividends do escape NI and so may be a useful way of extracting profits from the company. The effective tax rate for any dividends withdrawn, after taking into account corporation tax, is 40%, the same as if you had earned the income as a sole trader. But, if you need to retain the profits in your business, there may be a tax advantage in incorporation. Company profits are taxed at 10% for the first £10,000 and then 20% up to £300,000, compared with the 40% income-tax rate. If you do choose to incorporate you will need a tax-efficient route. There are two methods and both defer capital-gains tax on the transfer of the business. Ask your accountant which route suits you best.