If you’re thinking about starting up, you must carefully consider whether to form a limited company straight away or hold off for a while and become a sole trader.
You may think forming a limited company will save you tax and must therefore be the best route. However, many start-ups incur considerable costs in their initial months. And even if you do not have sizeable initial outgoings, you should still factor in a realistic margin for error in your budgeting.
You will more than likely have a “learning curve cost” if this is your first time in business or if you’re going to be operating within a sector of which you have no prior experience. In either case, you should not expect the same return straight away as your more experienced competitors.
If you make a loss as a sole trader, it can be set against your employment income for previous years, which in all likelihood will give you a handy refund after the first tax year. If you make a loss as a limited company, it can only be carried forward and set against future the company’s profits. If the company never makes a profit, it will be wasted.
Even if you’re more confident that your business plan will be a success, you may still profit from waiting until you form a company. As a sole trader, you can build up custom, contacts, brand awareness and reputation in the business. From a tax point of view, this goodwill can be sold to the company. Future drawings from the company can be taken in the form of a director’s loan repayment, which will be especially beneficial if you expect to be paying tax at a higher rate.
You can set up as a sole trader by simply telephoning HMRC or registering online, whereas the route for a company formation is more complex. Ongoing accountancy costs are bound to be higher and Companies House will publish your company’s financial results for anyone to see – including your competitors, suppliers and potential clients.
Yes, if your salary and dividends are organised properly, a company can save you considerable tax. It can also limit your liability to company debts. But the decision is not so straightforward. If you want to protect your trading name, you can always form the company and leave it dormant at Companies House until you are ready to start trading.
A limited company can save you tax in certain situations, but it is not always the best way to start out. A brief review of the options with your accountant could save you time and money in the long run.