Incorporated vs Unincorporated Companies

Set Up

When setting up a sole trader business there are no set up fees, all that is needed is to register for self-assessment with HMRC. You need to inform HMRC by the 5^th October following the first tax year of operation (for example if you trade by 5^th April 2023, you will need to register by 5^th October 2023), however we recommend our clients to register as soon as possible.

A partnership is set up in a similar way to a sole trader, however a SA400 form is needed to register the partnership with HMRC. A partnership should include a partnership agreement which will incur legal fees. A separate business bank account does not have to be opened when forming a sole trader or partnership, however it is recommended.

When setting up an incorporated company, a company must be formed by filing form IN01 with Companies House. This can be done online for a fee of £12, and if a formation agency is used an agency fee may be applied. Companies House will automatically inform HMRC of any new companies, who will then send a CT41G form to the company to confirm the details and tax status of the company. A separate business bank account must be opened when a new incorporated company is trading.

Administrative issues

A sole trader must maintain adequate books and records to support the contents of the personal tax return. Individuals with trading income exceeding £10,000pa will need to maintain their records digitally from 6^th April 2024, in line with HMRC’s Making Tax Digital for Income Tax requirements. Up to this date, there are no statutory requirements for accounts or business information, however after this date, individuals will need to report their profits/losses with HMRC quarterly. A PAYE scheme is not required unless the proprietor employs any employees. An audit is never required regardless of the size.

An incorporated company must maintain adequate books and records to meet the requirements of the Companies Act. Annual accounts need to be completed and filed with Companies House, along with Corporation Tax returns which need filing with HMRC. As an incorporated company is a separate legal entity, a PAYE scheme is required as everyone is an employee. An audit is required when a company exceeds the relevant criteria under the Companies Act.

Taxation & NIC

As a sole trader, income tax is payable on all profits ranging from 20-45% dependent on the level of profits made. If the liability exceeds £1,000, the tax is payable in three instalments payable in January and July, which includes ‘payment on accounts’ towards the following tax years. Class 2 & 4 National Insurance will also be payable by the sole trader; however, these are dependent upon the level of profits and age of the trader.

An incorporated company must pay corporation tax on any taxable profits, which are payable 9 months after the accounting period. ‘Large’ companies generally pay tax by quarterly instalments. The current corporation tax is charged at 19%, however this is rising to 25% on profits exceeding £50,000 from 1^st April 2023. Class 1 Employer NIC must be paid on earnings and benefits given. Class 1 Employees NIC will also be paid on any earnings.

Motor expenses

As a sole trader, you will be able to claim all business motoring costs against your taxable profits, and generally claim capital allowances on the business use element of any vehicles used in the trade.

As an incorporated company, a statutory mileage allowance is used (currently 45p up to 10,000 miles and 25p thereafter) if employees use their own vehicle for business purposes. There are further tax implications if the company purchases a vehicle outright, or if the company issues an employee with a company car, so please contact Direct Peak to discuss these implications further.

Capital gains

As a sole trader, capital gains arising are assessable on the owner at 10/20% (Residential property 18/28%), and an annual exemption is available (currently £12,300). Business Asset Disposal Relief is available on qualifying disposals of business/partnership interest or sale of assets at cessation at a rate of 10%. There are also deferral reliefs available such as gift relief, rollover and EIS reinvestment relief.

For an incorporated company, chargeable assets sold by the company will give rise to a gain assessable on the company at the normal corporation tax rate (currently 19%). There is no annual exemption available, however indexation allowance is available to companies (frozen from December 2017). Business Asset Disposal Relief is available on the disposal of shares in an unquoted trading company where the individual meets all the personal company requirements and works for the company. Rollover relief is available to defer company trading gains, and double taxation may occur where gains arise within the company and are then taxed again if the share increase in value before they are sold.

Trading loss reliefs

Trading losses for a sole trader can be set against other income of the sole trader for the current and previous year. Losses made in 2020/21 and 2021/22 can be carried back up to three years. Sole traders can only carry forward losses against same trade profits.

As an incorporated company, a trading loss can be offset against other profits the company in the current & one preceding year (this has been extended to three years for periods ending between 1 April 2020 and 31 March 2022). Losses can be carried forward against future same trade profits.

Extraction of funds

As a sole trader, all trading profits are taxed through self-assessment, regardless of whether they are ‘drawn’ from the business.

Trading as an incorporated company, income is only taxed when it is withdrawn from the business. Salaries are taxed through pay as you earn, and interest, rental and dividend incomes are taxed through self-assessment. Planning opportunities are available to minimise tax liabilities through a combination of dividends and salary, so please contact Direct Peak to discuss further.

Pension contributions

Personal tax deductions on own contributions are subject to statutory limits (currently £40,000 pa).

An incorporated company can save corporation tax (currently 19%) on any qualifying pension contributions made.