There are some differences between what is allowable as an expense for tax purposes for a sole trader and what’s allowable for a limited company. Whichever business structure is operated though, all business expenses must have been incurred “wholly and exclusively” for the purposes of the business. This means that the costs must have been incurred while actually running the business or while trying to attract new sales or clients for the business.
As a director of a limited company is considered an employee of the company, a range of tax-free benefits and perks (e.g. purchase of a mobile phone or computer for the business) is available, so long as it both are bought in the name of the company and are used by the business for the purposes of performing or attracting new business. A sole trader or freelancer can also buy a phone or computer for business purposes. However, the difference is that the owner would need to account for any private-use element of the equipment bought for business purposes and then apportion any “private use” against expenses for tax purposes.
COMPARISON CHART SOLE TRADER V LIMITED COMPANY EXPENSES
|SOLE TRADER||LTD COMPANY DIRECTOR/SHAREHOLDER|
|Employment status of a sole trader is self-employed.||For income tax and national insurance purposes, company officers, i.e. a director is treated as an employee.|
|Sole traders pay income tax on all profits and pay Class 2 & Class 4 national insurance. Income tax rates are generally higher than corporation tax rates||A limited company pays corporation tax on its taxable profits. Corporation tax rates are lower that personal income tax rates.|
Office holders (e.g. a director) is an “employee” and paid via PAYE + national insurance on their earnings. Salary is typically kept low to take advantage of other benefits such as dividends.
Dividends and distributions made by the company are subject to tax, but there is a £5,000 tax-free dividend allowance.
Beware: if IR35 or any of the other managed services provisions apply then the company must deduct PAYE and NICs from its income.
|For sole traders, losses can be offset against other income, but there is a cap on the amount of relief that can be claimed for losses and interest payments.||A limited company can offset its trading losses against its other income, but not against the income of an individual.|
|Sole traders may withdraw cash from the business without impacting tax. But enough money must be available to pay tax and national insurance as well as business expenses such as broadband and phone.||A limited company is taxed if it withdraws cash from the company. If it is a distribution it is taxed as a dividend. If it is earnings it is taxed via PAYE and subject to NIC.|
|As there is no distinction in law between the business and the business owner, a sole trader is free to borrow from the business bank account. Tax relief on bank charges and interest on loans or overdraft are restricted according to the purpose.||Director loans are permitted within set limits, but there are tax implications.|
|Sole traders can only pay into a Personal Pension.||A limited company can run a Company Pension Scheme, probably more generous in terms of benefits and limits than a Personal Pension. A SIP / SAS, or an unapproved scheme may be used to hold assets.|
A limited company must offer all employees an auto-enrolment pension scheme.
|The sole trader is personally liable for debt.||If a company fails, the director’s liability is limited to the amount unpaid on shares, unless a personal guarantee has been made against the company’s borrowing.|
A company director can be held personally accountable if s/he continues trading when the company is insolvent.
|The self-assessment tax return sole traders must complete and file annually includes a balance sheet section, but the accounts do not have to be submitted to HMRC unless subject to investigation.|
Taxable profit under self-assessment must be prepared in accordance with Generally Accepted Accounting Practices (GAAP). Soon, all small businesses and landlords will be required to record their business transactions quarterly, using Making Tax Digital-compatible software.
|Limited companies must prepare annual accounts under the provisions of the Companies Act.|
Full accounts for corporation tax must be submitted online in iXBRL with HMRC. Short accounts can be filed with Companies House. Accounts must be prepared in accordance with GAAP.
|A sole trader can withdraw any amount of profits from the business, but this is not classed as remuneration as the trader is not an employee of the company. Paying fees to a spouse or family members must be commercially justified to be allowable for tax purposes.||There is no restriction on the size of salary taken by a limited company director, but the remuneration will be subject to PAYE and NICs.|
Paying a salary to a spouse or family members must be commercially justifiable for tax purposes.
Beware: if your contracts fall inside IR35 or the company is a managed service company, PAYE and NICs will apply to income.
|Sole traders can claim tax relief for expenses that are incurred wholly and exclusively for the purposes of the trade. If a business expense can be apportioned then it can be claimed against tax; an adjustment must be made for the proportion of any expense that relates to “private use”.|
Private use relates mostly to telephone/broadband, power, home office rent, consumption of goods, and vehicular expenses.
|A limited company obtains tax relief for its expenses if they are incurred wholly and exclusively for the purposes of the trade. If a director incurs private expenses through the company, they may be treated as earnings.|
|A sole trader can claim capital allowances on a vehicle, disallowing a proportion for private use.|
There is no adjustment for fuel benefit for sole traders. They should merely disallow a proportion of fuel costs in relation to private use.
|A limited company obtains full capital allowances on vehicles, irrespective of private use by employees. Cars can attract a benefit in kind charge, but this depends on list price and the vehicle’s C02 emissions. Low-emission cars can represent a tax break for family members on the payroll. Sometimes it’s better to run a personal car and to charge the company authorised mileage rates. It’s not tax efficient to provide company-car drivers with fuel for private use.|
|Mobile phones attract private use, so a tax add-back should be detailed on sole traders’ tax returns.||Providing the mobile phone is in the company name then it is tax free.|
|A capital allowance can be claimed on a computer. An add-back of allowances will apply if there is private use.||Providing the company needs a computer one can be bought through the company tax free.|
|Self-employed sole traders do not enjoy any tax-free benefits and incentives.||There are a number of tax-free benefits and incentives for limited companies.|
|A sole trader working from home can claim a deduction for mortgage interest/rent, council tax and light and heat.||A limited company director working from home can claim £4 per week without receipts for home expenses. Alternatively, the company can reimburse the director for light and heat, but cannot do the same for mortgage interest or council tax.|
|A sole trader cannot charge him or herself rent for using an office space at home.||A director of a limited company could draw up a licence with the company to rent a home office. That would enable recharging a proportion of mortgage interest and council tax. This would need to be declared as income by the director on a Self-Assessment tax return.|