One of my pet peeves is when people use the term self-employed to describe the status of people who run their own limited company. It leads to confusion in terms of how income is taxed and, when considering eligibility for the COVID19 relief schemes, has caused lots of arguments and anguish.
In strict terms, someone who is self-employed works alone in their own unincorporated business, or with other people as a partner in partnership (including a limited liability partnership “LLP”). There is no separation between a self-employed person and their business*.
If you trade through a limited company, you are a director-shareholder. A company and its owners are separate entities with their own legal identities. Therein lies the biggest, and arguably the most important, distinction that anyone going into business needs to understand.
So what is the difference between being self-employed and trading as a company?
|Unlimited liability for business debts – creditors can make a claim against personal assets, and, in serious cases, bankruptcy is possible||Liability for company debts limited to the value of share capital owned so personal assets protected, subject to rules on fraudulent/wrongful trading or misfeasance|
|Can be sued personally||Difficult and rare under UK law for anyone to sue a director personally for a company’s wrongdoing – common exceptions include corporate manslaughter, or under health and safety or environmental legislation|
|Simple to set up and close down||Relatively simple to set up – more complicated rules surrounding closure|
|Finances remain private (other than HMRC)||Accounts must be published at Companies House (reduced disclosure for micro and small entities) plus a confirmation statement must be filed annually|
|HMRC stipulate how financial records need to be set out||Format of accounts set out in financial reporting standards as well as HMRC|
|Accounts may be prepared on a cash basis if turnover is less than £150,000||Accounts must be prepared on an accruals basis (also called conventional accounting)|
|Lenders look to personal assets for security||Raising finance generally easier although lender can still ask for personal guarantees if insufficient collateral in company’s assets|
|Pay income tax on the profits of their trade regardless of whether money has been taken out of the business bank account||Company pays corporation tax on profits, currently 19%|
Individuals pay income tax on withdrawals % depends on the nature of the income
|Income tax payable via self-assessment||Income tax payable by individuals via PAYE and/or self-assessment|
Corporation tax payable by the company 9 months + 1 day after end of accounting period
|Pay Class 2 (£3.05/week in 2020-21) and Class 4 National Insurance at 9%||Pay Class 1 National Insurance on salary at 12% (and 2% above the upper earnings limit)|
The company also pays Class 1 Employer NIC at 13.8%
There is no NIC on dividends
|Can be an employer but cannot employ yourself||A director is an officer, but is not automatically an employee, because tax and employment law have different definitions|
|Can make contributions to a personal pension with tax relief claimed via self-assessment||More choices with regards to pension contributions, which may have more generous benefits & limits than a personal pension|
|Only have Auto Enrolment duties for employees||Have Auto Enrolment duties even if no employees other than yourself|
|Assets owned personally||Assets owned by company|
|Tax relief reduced for private use of assets e.g. car||Income tax payable for private use of assets AND company pays Class 1A NI at 13.8%|
|Can withdraw cash from business accounts with no tax impact||Bad practice to use the company bank account as an extension of personal funds|
Any cash withdrawn must be categorised as salary, dividend or loan
+ Loans over £10K may be subject to income tax as a benefit-in-kind
+ ALL loans outstanding 9 months after the end of the accounting period value are subject to a penalty tax on the company of 32.5%
|Can withdraw as much cash as available or even borrow funds from the business||The company must have sufficient distributable reserves to declare dividends, governed by rules designed to protect the company’s creditors|
Official procedures have to be observed to ensure compliance with Companies Act including calculation of reserves, minuted vote by board/shareholders, issue of dividend vouchers and recording of transactions in accounts
|Limited ‘perks’ deductible for tax||More ‘perks’ available but strict tax rules|
|Can claim Self Employment Income Support||Cannot claim Self Employment Income Support|
* LLPs are treated like a limited company legally but the members are treated as self-employed for tax purposes (other than fixed profit LLP members who may be classed as employees under anti-avoidance provisions).