What structure should I use for trading?
If you are UK based and trading in any of the financial markets, you have effectively two options of vehicle through which you may run your trading activities.
If you are self-employed in UK working on your own, from a legal point of view, you and the business are effectively one and the same. Therefore, any losses that are incurred are your own losses and you may end up losing your own personal assets.
However, on the flip side, any profits are truly your own profits and not owned by any corporate vehicle between you and the actual trade.
From a tax point of view, you are liable to both Income Tax and National Insurance on any profits that you may earn, or if in a partnership, the share of the profits that are attributable to you.
In the 2014//15 tax year, this means that the first £10,000 is Income Tax free and the next £31,865 is taxed at 20%. Any additional profits over and above this is then taxed at 40%, with the 45% tax rate hitting where profits exceed £150,000 in total.
Class 4 National Insurance meanwhile has slightly different bandings just to confuse the issue. The first £7,956 is National Insurance free, and the next £33,909 is then subject to 9% NI before falling to a rate of 2% for any profits over and above this.
Therefore if your profits exceed £41,865 you will find that your tax bill above this amount is effectively 42% (or 52% if your profits exceed £150,000!). In other words, unless you make less than around £8,000, the minimum tax rate that you will pay is around 29% potentially increasing to around 52%.
In addition to this, self-employed individuals making profits of more than £5,885 are also liable to another form of National Insurance called Class 2 National Insurance. This is a flat rate of £2.75 per week and is usually paid by a direct debit on a monthly basis.
The payment of tax through self assessment (Income Tax and Class 4 National Insurance) is payable at the end of January following the tax year with payments on account payable in advance of the following tax year (but based on the last year) due also at the end of January and end of July.
Generally speaking, remaining purely self-employed is the most straight-forward option for traders, although once profits exceed approximately £25,000, it is often found that a corporate vehicle such as a limited company or hybrid LLP becomes less expensive overall, even taking into account increased professional fees. In addition, you should consider whether you wish to risk losing your own personal assets outside of the business.
A limited company is a separate legal entity to the owners (shareholders) of the company, and thus the owners (who are often also the company directors – the individuals running the business) enjoy limited liability in the event of the business going bust, meaning that they would only lose the money/assets that they have invested in the company itself, except in exceptional circumstances such as fraud.
If a limited company is used to trade through, all profits/losses are made by the limited company and they are subject to Corporation Tax, at the following rates in the 2014/15 tax years:
- First £300,000 taxed at 20%
- Next £1,500,000 taxed at 21.25%
- Remainder taxed at 21%
Note the above rates may be adversely affected where you or a member of your close family runs another limited company that is not entirely separate to your trading activities.
However, you may also face a tax liability personally based on how you are withdrawing your income from the limited company.
Generally speaking, the optimal method for a director/shareholder to withdraw money from their own limited company is by way of a small salary of up to £7,920 per tax year together with dividends, although again this depends on the individual’s circumstances.
Drawings (including the salary) above approximately £41,000 will result in additional higher rate tax being payable by the individual. Should any amount be taken additionally as a dividend then tax of approximately 25% of the excess will be payable through the self assessment system in the same way as the self-employed individual shown above. For example, if £50,000 was drawn by way of a salary of £7,920 and net dividends of £42,080, the resultant tax liability would be approximately £3,202 (excluding any payments of account for the following year).
As compared to a self-employment based structure, Limited Companies remain generally more tax-efficient particularly where profits (and drawings) do not exceed £300,000. However, as profits (and drawings) increase above this level, self-employment structures again become slightly more tax-efficient, although you would again face unlimited liability in the event of losses being made.
Please note that figures stated within this article presume that the only form of income is that from the trading activities and personal circumstances may differ from the examples shown.