Thanks for downloading our 7 tax tips guide. Have you had chance to read it? What did you think?

Along with this one, I’ll be sending you a few emails over the next few days that go into more detail on each of the tax saving tips. Today we’re going to be focusing on how your trading structure can help you be tax efficient, so let’s dive in.

Consider your trading structure – could it be more tax efficient?

If your business is not currently operating as a limited company then the answer is….yes it could! However, tax efficiency isn’t the only consideration when choosing the trading structure for a business. In addition, you may want to consider the perception of your business to the outside world, suitability for future plans or operational flexibility to name but a few, read on to discover the pros of each trading structure.

Pros of being a Sole trader:

  1. Control
  2. Operational flexibility
  3. Fewer statutory obligations
  4. Profit retention in the short term
  5. Privacy

Pros of being a Limited Company:

  1. More tax efficient
  2. More favourable for the facilitation of financing growth
  3. More profitable in the long term

So how will trading as a limited company reduce your tax bill?

As a sole trader, an individual must pay personal tax on all profits over and above their personal allowance. For most tax payers the personal allowance is £12,570 for the 2024/25 tax year (The income limit for the Personal Allowance to apply is £100,000, at which point the Personal Allowance goes down by £1 for every £2 of income. It can go down to Zero).

Above the personal allowance, tax is paid at the basic rate of 20% (up to £50,270 income) and 40% as a higher rate taxpayer (over £50,270).

Slightly different tax rates apply for Scottish taxpayers which are not covered in this article.

When operating a business as a sole trader, other personal tax issues need to be considered such as the withdrawal of child benefit once your income goes over £60,000 and the personal allowance beginning to be withdrawn once your income breaches £100,000.

In addition to tax, a sole trader will also be subject to two forms of national insurance, Class 2 and Class 4.

By contract, the taxes imposed by HMRC on a limited company fall into two categories, these are:

  • Company tax
  • Personal tax

Company Tax

  • A limited company currently pays corporation tax on profits at a rate of 25%
  • Your accountant will register your company for Corporation Tax once your company is registered with Companies House (the registrar of companies in the UK), and will prepare your Annual Accounts each year. They will then submit them to Companies House and HMRC, together with a Company Tax Return showing in detail how much of the net profit shown on the Annual Accounts translates into taxable profit for the year. Operating as a limited company offers an extensive list of allowable expenses which your accountant can offset against your net profit to reduce the net profit figure to which the 25% corporation tax is then applied.

Personal tax

As a limited company director, tax on your personal income is payable in three ways;

  • Income tax
  • Dividend tax
  • National insurance

Income Tax

  • As a director of a limited company your tax is done through a Self-Assessment income tax return which you will need to complete annually.
  • Income tax rates for limited company directors are the same as they are for sole traders and the same income thresholds apply. However, you can legitimately pay yourself a small salary which equates to no more than the personal income tax allowance (currently £12,570) and take the rest in monthly dividends, this way you avoid paying income tax at all and instead pay the lower tax rates that are applied to dividends. The next email in this tax-saving series covers remuneration planning and there we will give suggested figures for this remuneration structure.

Dividend Tax

  • As a company shareholder, you will also pay tax on the dividends that you pay yourself. However, unlike salaried income, dividend income is not subject to National Insurance contributions, providing a significant tax benefit to limited company owners.

The table below shows the tax rates that are applied to different levels of annual dividend income for the 2024/25 tax year.

2024/25 Dividend Tax Rates and Thresholds

Thresholds 2024/25 Dividend Tax Rate2024/25
Personal Allowance: no tax paid on income in this band. £0 – £12,570 0%
Basic-rate tax payers £12,570 – £50,270 8.75% on dividends earned above dividend allowance.
Higher-rate taxpayers £50,270 – £125,140 33.75%
Additional-rate taxpayers £125,140 upwards 39.35%

There is no requirement for the owner to withdraw all profits from the business if they do not need to, and it can certainly prove tax efficient to leave some profits retained in the company for extraction at a later date or to re-invest in the company (e.g. to invest in equipment or staff). A sole trader is obliged to pay tax on the profits whether the money is required to be drawn personally or not.

National Insurance

As an individual, you are liable for Employees’ NICs on the salary you draw down from your company but as mentioned above, most owners of limited companies pay themselves a low salary, sometimes below the NIC threshold, to minimise their exposure to both income tax and National Insurance Contributions. This is perfectly legitimate and is one of the reasons why operating as a limited company is the most tax efficient option for small businesses.

We hope this email has helped you to gain a greater understanding of the effect that trading structure has upon your tax. However, if you have any further queries or wish to discuss the tax efficiency of your business trading structure further, please do not hesitate to call us on 02475 185286 or book your free consultation.

Don’t forget to keep an eye out for the next tax saving tip which is all about how you can pay yourself tax efficiently. I’ll send it to you tomorrow.