Self-Employment v Limited Company Print
There are many reasons why an individual may prefer to carry on business through a limited company rather than as a self-employed individual. If a corporate structure is required, or preferred, then the director/shareholder needs to consider whether he should be extracting profits by drawing a salary/bonus, or by taking dividends.
The transfer of the goodwill, plus any other chargeable assets of the business such as land and buildings, may give rise to a liability to Capital Gains Tax (“CGT”).
For transfers of a business to a limited company, individuals are not able to claim Business Asset Disposal Relief (“BADR”) on the disposal of goodwill, although BADR remains claimable on other chargeable assets, such as land and buildings included within the transfer. In most cases, however it was the ability to obtain Entrepreneurs’ Relief on the value of the goodwill transferred to the limited company that attracted many self-employed traders, or partnerships to incorporate for a cash consideration.
If the transfer to a limited company is being carried out for other reasons, and consideration is not required for the business assets, the transfer may be carried out so that Incorporation Relief is due. This is where the business plus all the assets of the business (or all the assets excluding any cash) are transferred as a going concern to a company in exchange for the issue of new shares in the company. The effect of Incorporation Relief is to defer any CGT liability until the transferor disposes of his shares in the company.
If the transferor is not transferring the entire business to a company, he may still be able to elect to hold-over the gain where the assets are transferred to the company for no consideration, or for less than their open market value at the date of transfer.
It is recommended that sufficient income is taken as a salary on which NIC is charged, or at the Lower Earnings limit for NIC purposes (£6,240 per annum for 2021/22) so that entitlement to the State Pension, and other earnings-related benefits dependent upon NIC contributions are not forfeited for the year.
The following table compares the overall position for 2021/22 of trading either as self- employed, (which includes partners in partnerships) or through a limited company by taking the entire income as salary, or by taking a salary of £10,000, to produce a small NIC liability, and the remainder of the income by way of dividend:
2021/22 Net Spendable cash after tax & NIC
|Profit before Dividend||Tax & NIC, £||Self-Employed, £||Employed, £|
From 1 April 2023 the rate of corporation tax is increasing to 25% for companies whose profit exceed £250,000. For profits between £50,000 and £250,000 a marginal rate of corporation tax will apply, and the following table shows the anticipated net spendable cash remaining for 2023/24:
2023/24 Net Spendable cash after tax & NIC
|Profit before Dividend||Tax & NIC, £||Self-Employed, £||Employed, £|
For 2021/22, and 2022/23 taking a small salary and the balance as dividends remains more tax efficient than employment income. The difference between self-employment and salary and dividends is far less marked although salary and dividends have a slight advantage up to income of £147,957 from which point self-employment income begins to be more advantageous. From April 2023 when corporation tax increases, the point at which self-employment and a small salary and dividends equate reduces slightly to £138,049. Thereafter, self employment taxes become significantly more advantageous with a tax saving of approximately 10%. Above £200,000 the saving between employment income and a small salary plus dividends becomes marginal, and the ability to pay increased pension savings with a higher salary may make employment income more attractive.
The above examples do not take into account any other considerations such as taxable benefits that may arise under employment, as compared to the tax adjustments that would be due under self-employment. Nor do the figures include any additional costs that may be incurred by trading through a company. In any event specific advice should be sought before implementing a change in business either from self-employment, or partnership to limited company status, or vice-versa.
Incorporation will remain preferable where the business is making greater profits than are required by way of drawings, and the excess profits are retained within the company net of corporation tax.
If you are the director/shareholder of a small limited liability company you may wish to consider disincorporation, and trading as a sole proprietor, or in a partnership. In particular, this is likely to be the case if for any reason the taking of dividends is inappropriate to your requirements. The main advantage of disincorporation in these circumstances is that a considerable saving of NIC may be achieved, particularly if earnings exceed the upper earnings limit for NIC of £50,270. The self-employed, and partners still enjoy considerably lower NIC contributions than employers/employees.
Examples of the potential savings are illustrated below, based on the contributions payable for 2021/22:
National Insurance Contributions
The self-employment contributions shown above include both the Class 2 and Class 4 contributions.
PAYE is not payable on any income of the proprietor of a self-employed business, and no tax need be deducted from drawings during the year.
There are no taxable benefits assessable on the self-employed, such as car, fuel etc. A deduction in respect of the private element of the expenditure incurred by the business is made in the taxation computations, but unless there is only a small proportion of business use of the car, the tax consequences are likely to be much less severe than under PAYE.
There are certain disadvantages in choosing the self-employed/partnership route, and the main considerations to be taken into account are:
In the event of insolvency, the proprietor’s liability is not limited to his investment in the business. Therefore, if there is a risk of insolvency, transfer to self-employment should be viewed with caution. Consideration could be given to transferring the business to a Limited Liability Partnership as this should have much the same protection as a limited company.
A proprietor is assessable on the whole profit arising in the year whereas a director may choose to leave profits in excess of his personal requirements in his company and pay corporation tax instead. In the event that profits are substantial, this could lead to the proprietor paying income tax at up to 45%, plus an extra 2% Class 4 NIC on the majority of the profits whereas they may only attract corporation tax at the rate of 19% (up to 25% from 1 April 2023). The use of a company to shelter profits in this way should only be viewed as a deferral, as it is likely that further tax would become payable on the eventual withdrawal of the accumulated profits from the company.
If the business incurs high expenditure on capital equipment, even though capital allowances may be claimed over a period of time, this can result in tax being payable on profits used to acquire the equipment. This is of less relevance now that the Annual Investment Allowance is likely to cover the majority of such expenditure by the self-employed. (See section on Capital Allowances.) Although a company would have to pay corporation tax on the same profit, the rate of corporation tax payable is likely to be substantially lower than the income tax and Class 4 NIC.
It may be possible to avoid the NIC liability in a company by paying dividends instead of remuneration where the directors are also the shareholders of the company, and this is discussed in the section “Salary v Dividends”. It should also be noted that from 1 April 2023 the benefit of dividends will be greatly reduced.
Payment by way of dividends may restrict the amount the company could pay in pension contributions on behalf of those directors. If no salary is paid, the directors may find that they are not entitled to a State Retirement Pension, or other earnings related Social Security benefits. It should also be noted that companies do not obtain any tax relief in respect of dividends paid to their shareholders, which must be paid out of retained profits, after tax.