When should you transfer your business from trading as a sole trader to incorporating the company?

Friday, June 7th, 2019

There are long-standing assumptions around when it will be more tax efficient to incorporate and we explore them hear.  By the virtue that even profits of £25,000 would be better off as an incorporated business as there is no requirement to pay Class 4 NI on dividends but you must weigh this up with the increased costs of running a limited company.  Accountancy fees are normally higher, Companies House levy fees for your annual confirmation statement etc and the time of extra administrative duties all mount up.

Smaller business that are trading as sole traders with profits around £18,000 to £20,000 might want to consider bringing in their spouse as a partner and utilising their personal allowance too, so too very profitable sole traders, those with profits above £150,000 will pay less tax and NI if they remain unincorporated.

Q. Is there an easy way for me to see if I would benefit?

A. For the 2019/20 tax year the comparison is as follows for a sole trader making £30,000 profit:

Sole trader £ Company £
Gross profit 30,000 Gross profit 30,000
Personal allowance (12,500) Salary taken (8,632)
Taxable amount 17,500 Employers’ NI (0)
    Net profit 21,368
    Corporation tax (4,060)
    Available to distribute 17,308
Tax (3,500) Tax (858)
Class 2 NI (156) Employees’ NI (0)
Class 4 NI (1,923)    
Total tax/NI 5,579 Total tax/NI 4,918
Saving through incorporation £661

The saving is modest, and it may well be swallowed up by increased accountancy fees purely because there is more work to be done to meet your obligations.

Q. If your profits increased to say £60,000 would the results differ?

A. The general rule is that the higher the profit the more beneficial it would be to incorporate.

Sole trader £ Company £
Gross profit 60,000 Gross profit 60,000
Personal allowance (12,500) Salary taken (8,632)
Taxable amount 47,500 Employers’ NI (0)
    Net profit 21,368
    Corporation tax (9,760)
    Available to distribute 41,608
Tax (11,500) Tax (2,741)
Class 2 NI (156) Employees’ NI (0)
Class 4 NI (3,923)    
Total tax/NI 15,579 Total tax/NI 12,501
Saving through incorporation £3,078

As you can see, significantly higher savings and whilst you still need to consider increased costs for accountancy and such like it would be beneficial in this case to incorporate.

Q.  What happens if my profit is much higher, say £150,000?

A. At this level of profit an individual would lose their personal allowance so there would be little point in taking a salary as a limited company due to the associated additional costs for running a payroll (please note however that we include directors payroll in our monthly fee at no additional cost).

Sole trader £ Company £
Gross profit 150,000 Gross profit 150,000
Personal allowance (0) Salary taken (0)
Taxable amount 150,000 Employers’ NI (0)
    Net profit 21,368
    Corporation tax (28,500)
    Available to distribute 121,500
Tax (52,500) Tax (29,394)
Class 2 NI (156) Employees’ NI (0)
Class 4 NI (5,723)    
Total tax/NI 58,379 Total tax/NI 57,984
Saving through incorporation £485

These figures would alter slightly if you drew a salary of £8,632 as it would decrease your profit a little.

Q.  What would you recommend for me and my business?

A.  That advice is more complex than it used to be, we would need to complete an analysis of your business and would require more accurate forecasts of income levels going forward.  It is expected that profitable companies with levels of profit between £40,000 and £140,000 would benefit from being a company rather than a sole trader even with the consideration of additional associated costs.

Q. Are there any other advantages?

A.  As a director of a company you can chose when to extract profit via dividend  and you are only taxed when the dividend actually arises so in theory you can leave the profit in the company and not draw a dividend and therefore save more in tax as opposed to a sole trader, who are taxed on the profit level, regardless of whether they draw the profit down for themselves or not.

You may also want to consider having a spouse who has no other income joining the company as a shareholder as you could then take advantage of both personal allowances, both dividend allowances and basis rate bands.

We would however advise drawing up a shareholder’s agreement whenever there are more than one director and shareholder and make provision for any disputes that may arise in the future.

If you’re still unsure, contact us and we will be happy to discuss the options best for you.


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