You have maybe left employment for a company, and you are planning to start up on your own – or you want to add a new firm to an existing trade that you carry on – or perhaps you want to start out from the beginning of your career as an entrepreneur.
What sort of a structure do you want to have around you – a self-employment model (sole trader) or a business structure (probably a limited company)? The answer for you will involve thinking about the direction in which you expect to go – do you expect to take on staff or fellow-owners? Will you diversify? Or will you aim to remain as a solo operator? And in addition to these commercial questions, there are financial, taxation and legal issues to consider, which we will briefly outline here. Whichever way you decide to go, you will need business accounting services.
Going Solo
Sole traders pay income tax and National Insurance Contributions on all their profits from trading or professional services. It doesn’t matter whether the trader takes profits out of the business. It is simple: there is no additional tax to pay as a result of withdrawing profits.
For pension planning purposes, your profits are classed as “relevant earnings”. This means that you are allowed to pay part of them into a personal pension plan and you are given full tax relief.
Your car may well be used in the pursuit of your business; and the good news is that you are able to claim capital allowances on the purchase of the car and on its running expenses – in either case the claim has to be in line with the ratio of business mileage to the car’s total mileage.
You will very likely, at least in the early stages, work from home; in which case you will normally be able to claim deductions from gas, electricity, and property insurance. But beware of over-claiming, for fear that your deduction claims will risk breaching the exemption allowed for private residences and you will be taxed as having business premises, including the payment of business rates. This is normally avoided, so long as there is a clearly defined private dwelling section in your home/work building.
There is a tax advantage to your spouse being active in the operation. This means that they can legitimately be paid at a market level for their work. Another option is to make them your business partner; then you can share the profits (if any) and the associated tax after taking advantage of your individual reliefs.
Losses are often made in the early years of a business, and you can set off a loss against any other income that you have in the same year, or in the previous year. The process can be carried back three tax years in all, generating tax refunds. This is an area where you should definitely consult a tax adviser.
Keeping Company
When you set up a company, you automatically become a shareholder and an employee. You – or rather your company – must pay corporation tax on the profits (if any), but your salary can be deducted from the amount on which corporation tax is paid.
You do not strictly have to pay yourself a salary: but there is a national minimum wage and so HMRC can decide that part of all of any dividends is actually paid, in which case you have to set up a PAYE system and be paid after NI and income tax deductions. This may well be the best approach long term anyway to ensure that you amass the minimum number of working years’ NI contribution to secure the maximum state pension.
Your salary is classed as ‘relevant earnings’ for pension purposes. Assuming that you have registered as a director, you are entitled to have either a personal pension scheme or an occupational pension scheme.
You can claim that your company is providing you with a car and thus claim capital allowances for its purchase cost and for running costs. However, under fringe benefits rules you will pay income tax on the benefits.
If you take a loan (or one of your family does) from the company, and it is not repaid within a 9-month period after your accounting year, then the company must pay tax of 25% on the loan. If you write off the debt then the company gets back the tax deduction, but the recipient is then taxed on it, as if it were a dividend.
Bear in mind that if you have received pay in the year then you are liable to income tax, even if the company then makes a loss – it can set off losses against previous year profits or carry them forward, but that does not allow you any relief on your personal tax.
You can ‘suck it and see’ as a sole trader initially then decide to incorporate there are no specific downsides to this in tax terms and you can carry forward any early losses into the company.
The opposite process of ‘disincorporation’ may be a little more hazardous as there is the possibility of tax penalties and as always, it is best to consult a small business accountant.
If you need a tax adviser or general small business services, contact us.
