Sponsored content: Should you register with HM Revenue & Customs as a sole trader or limited company?

Should you register as a sole trader or a limited company?

Should you register as a sole trader or a limited company? - Credit: Getty Images/Brand X

What do you think your first year profits will look like? This may sound like a question from Dragons Den, but it is an important one if you are starting a new business.

And it is a question that Keith Senior, a director of west Suffolk-based Jacobs Allen Chartered Accountants and Chartered Tax Advisors, asks new clients when they are debating whether to register as a sole trader or a limited company.

Many people will anticipate that operating a business in a limited company will reduce the amount of tax they need to pay.

“You may find it is not worthwhile running a limited company in the early days; it is not always more tax efficient,” said Mr Senior. “You can always start as unincorporated and transfer the business into a limited company later without any adverse tax consequence.”

Before he can advise his clients, he asks them for an idea of their forecasts for the business.

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“Very often people don’t have a clear idea of what their anticipated results will be,” he said.

“Our first piece of advice would be to work out some form of business plan and identify what financing you might need to arrange.

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“Start with the item you are selling - is it goods or services? What will this product or service cost you to produce or deliver? When will you receive payment and when will you have to pay for your costs?

“Then you need to look at how you will generate sales and what work is involved, how long it will take and in doing that, establish what that sales generation will cost you.

“From these anticipated sales leads you need to estimate the likely volume of sales and the timing of achieving these.

“Once you have done all of that you will have an idea of what your cash flow will look like and whether you will have to spend a lot of money to generate business before you are going to start turning a profit.”

Mr Senior continued: “Very often, even though the business is likely to be successful in the longer term, it can take small businesses quite a lot of time to generate initial sales, and it may well be that they make a loss in the first year or even the first couple of years.

“If you start off as a limited company, that loss will be locked into the company and you will get tax relief from that loss carried forward to set against your future profits.

“However, if you are a sole trader or in partnership, as an individual you can set that loss against your income for the past three years and recalculate your tax liability for those years.

“In consequence, you may get some tax back immediately, and that can help greatly with cash flow at that critical time.”

The record keeping requirements for limited companies are more onerous than those imposed on unincorporated businesses.

You have to produce more detailed accounts and you are more likely to need the help of chartered accountants, like Jacobs Allen, to ensure you are paying the right level of tax and complying with all of the more complex requirements.

“This will cost more,” explains Mr Senior.

“People also have to remember, if they set up a limited company, that is a separate entity to them as an individual and there are restrictions and rules about how you can extract money and the tax and other administrative implications of the different routes of doing so.”

For more detailed advice on setting up a business, registering with HMRC and tax liability, speak to Jacobs Allen Chartered AccountantsSee more from Keith Senior here

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