Difference between Sole Traders, Partnerships and Limited Companies
This post steers away from the current Corona Virus Pandemic and is focused on the difference between the various medium’s businesses can operate under and the tax obligations of each one. In recent times I have had many new clients come to me operating under a Limited Company, but are treating the income and tax liability as if they were a sole trader. This is largely due to the lack of understanding of the differences between the two, hence the reason why I write this post.
There a quite a few various entities that businesses can operate under, however I will focus on the three most popular ones which are:
· Sole Trader
· Limited Company
Each entity has differences relating to their accounting and legal obligations. I will focus briefly on the accounting aspects of each.
Sole Traders are essentially the same as the person operating the business. There is no separation from the business and the owner as the owner of the business is liable for all aspects of the business including the tax obligations. Any personal possessions of the business owner can be used as collateral in repaying any of the debts of the business as there is no separation between the business and the owner. Sole Traders need to register with HMRC for self-assessment with HMRC by the 5th of October following the end of the first tax year. Sole Traders are taxed via their self-assessment tax returns which are filed annually after the end of each tax year. In order to complete their self-assessment returns a sole trader will need to keep records of their income and expenditure for their business to calculate their taxable profits. From this figure they will be taxed accordingly depending on the tax band their income falls into. Sole Traders will also be required to pay class 2 and class 4 National Insurance Contributions. The value of these will be calculated when completing their self-assessment tax returns. A sole Trader will have the benefit of having a tax free personal allowance (currently £12500 for the tax year 2020/21) and income would have to be above this figure before any tax is paid.
A partnership is when 2 or more individuals get together to form a business. Their obligations are very similar to sole traders and they are also taxed via self-assessment tax returns. Like Sole traders, Partnerships need to be registered with HMRC by the 5th of October following the end of the first tax year. A partnership is required to fill in a Partnership Return (this is not taxed) and then from here each partner is required to fill in their own self-assessment tax return from which they are individually taxed. The tax rates for income tax and National Insurance is the same as per sole traders.
A limited company is a separate entity altogether from those who own it (shareholders/directors). A limited company must be formed via companies house. As the limited company is a separate legal entity the assets of the shareholders are not at risk and any risk is limited to the shareholders investment. Please note that any money, assets, etc held by the company are the company’s property and not those of the shareholders. A limited company will pay its tax via corporation tax. Each year a limited company will be required to fill in a corporation tax return and file annual accounts to both HMRC and Companies House. A limited company will also be required to file an annual confirmations statement with Companies House. Shareholders can receive dividends from the available profits of the company and these dividends are taxed via the shareholders self-assessment tax return. Dividends tend to be taxed at favourable tax rates than income tax.
There is more administration worked involved when running a limited company as there are more filing requirements with HMRC and Companies House in comparison to running a business via a sole trader or a partnership. This is the main reason why accountancy fees tend to be higher when running a limited company in comparison to the other 2 mediums.
For more information about setting up a new business or running your existing business and ensuring all tax obligations are met please contact us for a FREE NO OBLIGATION consultation by emailing us at firstname.lastname@example.org or call us on 0191 5111217.