Is operating through a personal company still worthwhile?

Sarah Bradford looks at the impact of recent tax and National Insurance contributions changes. 

----------------------

This is a sample article from our business tax saving newsletter - Try Business Tax Insider today.

---------------------

Historically, from a tax perspective it has been preferable to operate a business as a personal company and extract profit in the form of a small salary plus dividends than to run an unincorporated business.  

However, recent years have seen increases in the rates of corporation tax and dividend tax, a reduction in the dividend allowance, a cut in the rate of primary Class 1 and Class 4 National Insurance contributions (NICs) and the abolition of Class 2 NICs.  

In light of these changes, is operating as a personal company still worthwhile? 

Tax and NICs for the self-employed 

Where a person runs their business as a sole trader, the tax due on the profits of the business is not worked out in isolation. Rather, the liability is that of the individual, with the profits from the business being taken into account to work out their personal tax liability, along with any other taxable income they have.  

A sole trader is taxed on his or her income to the extent that it exceeds their personal allowance (where available). The first £37,700 of taxable income is taxed at the basic rate of 20%. Taxable income falling in the higher rate band (from £37,001 to £125,140) is taxed at 40%, and any taxable income in excess of £125,140 is taxed at 45%. 

For 2024/25, a self-employed trader will pay Class 4 NICs where their profits exceed the lower profits limit of £12,570. Class 4 NICs are payable at 6% on profits between the upper profits limit (£50,270 for 2024/25), and at 2% on profits in excess of this limit. 

From 2024/25, Class 2 NICs no longer applies. However, sole traders whose profits fall between the small profits threshold of £6,725 and the Class 4 lower profits limit of £12,570 will receive a National Insurance credit, which will provide them with a qualifying year for state pension purposes. Sole traders with profits below the lower profits threshold will still be able to make voluntary contributions, which for 2024/25 are set at the 2023/24 Class 2 NICs rate of £3.45 per week. 

Tax and NICs when operating through a personal company 

A company is a separate legal entity and distinct from the directors and shareholders. A company has its own tax bill and will pay corporation tax on its profits. The rate at which corporation tax is payable depends on the level of the company’s profits.  

Companies whose profits are below the lower profits limit pay corporation tax at 19% on their profits, whereas companies whose profits are more than the upper profits limit pay corporation tax at 25% on their profits. Where profits are between the two limits, marginal relief applies to give an effective rate of between 19% and 25%.  

The marginal rate is 19% up to the lower profits limit, 26.5% between the limits and 25% above the upper profits limit.  

Where a company has no associates, the lower profits limit is £50,000 and the upper profits limit is £250,000. For a company with associates, the limits are divided by the number of associates plus one. The limits are proportionately reduced where the accounting period is less than 12 months. 

However, where a business is operated as a personal company, this is not the end of the story; if the director wishes to use the profits outside the company, they will need to extract them, and depending on the method used, there may be some tax and NICs to pay. 

A typical extraction strategy is to take a salary equal to the personal allowance (£12,570 for 2024/25) and to extract further profits as dividends. As the primary threshold for 2024/25 is aligned with the personal allowance, there is no employee’s NICs to pay. However, as the employment allowance is not available to a company where the sole employee is a director (as is usually the case in a personal company), employer’s NICs is payable to the extent that the salary exceeds the primary threshold of £9,100 (unless one of the higher secondary thresholds applies). 

Any further profits are extracted as dividends. These are paid from retained profits which have already suffered corporation tax. In the shareholder’s hands, they are tax-free to the extent that they are covered by the dividend allowance, which for 2024/25 is £500. Thereafter, they are taxed at 8.75% where they fall in the basic-rate band, at 33.75% where they fall in the higher-rate band and at 39.35% where they fall in the additional-rate band. 

Sole trader vs personal company: crunching the numbers 

There is no substitute for ‘crunching the numbers’. The following case studies compare the tax and NICs payable at different profit levels where the business is operated as a sole trader and as a personal company. 

Case study 1: Profits of £50,000 

Sole trader 

Personal company 

Company 

Director 

At this level of profits, it is marginally more beneficial to operate as a personal company than as a sole trader. However, the costs of running a limited company are higher, and when these are taken into account, the sole trader may come out on top. 

Case study 2: Profits of £100,000 

Sole trader 

Company 

Director 

Where profits are £100,000, a person operating as a sole trader will retain £69,311 of the profits, while a person operating as a personal company will retain £66,862. Thus, the sole trader is the better option, retaining £2,449 more of the profits. 

At higher profit levels, it should be remembered that an individual starts to lose their personal allowance once their adjusted net income reaches £100,000. The allowance is reduced by £1 for every £2 by which adjusted net income exceeds £100,000, being lost entirely once taxable income reaches £125,140. This must be factored into the calculations. 

A more level playing field 

Recent tax changes have eroded the tax benefits of operating through a personal company and levelled the playing field, which one assumes was Parliament’s intention. However, the tax regime is not static, and with an election looming, there are likely to be further changes on the horizon.  

At present, the differentials between the different business vehicles are marginal and it is probably not worth switching between them in a bid to save tax. The decision as to which is the best vehicle for a business will depend on more than tax, and the wider considerations should be taken into account. A company provides the benefit of limited liability, which for a more risky business is a definite plus. However, this comes at a cost of higher administration costs from the need to comply with company law requirements. 

Practical tip  

When starting a business, compare the tax and NICs costs for different setups, but don’t forget to take account of the wider picture, too.