Something strange is going on with small businesses. Data published last week by the Office for National Statistics shows that the number of sole traders in the UK fell 4% last year – and has now declined 11% since 2019; by contrast, the number of small-business owners operating through companies rose 1% in 2023 and is up 4% on five years ago. The data feels counterintuitive because tax changes have made it progressively less attractive to run your business through a company structure in recent years.
In other words, some small-business owners may be paying more tax than they need to – possibly, say small-business experts, because the rules are poorly understood. Certainly, there are advantages to incorporating your business rather than operating as a sole trader. In particular, company owners aren’t usually personally liable for losses or liabilities incurred by their businesses, unlike sole traders. A company structure can also make it easier to navigate the IR35 rules on disguised employment, which have made life more difficult for contractors in recent years.
However, it is the tax position that is usually front of mind for small-business owners weighing up the pros and cons of incorporation versus sole trader status. And here, the scales have tipped in recent times. As a sole trader, you’ll pay income tax on the profits you make from your business – at a top rate of 20%, 40% or 45%, depending on whether you’re a basic-, higher- or additional rate taxpayer – as well as national insurance.
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By contrast, if you trade as a company, it will pay corporation tax on profits, at rates from 19% to 25% depending on how much it makes. However, you’ll also need to take money out of the company as your earnings, either by paying yourself an income or through dividends. You’ll pay the usual income and national insurance rates if you opt for income, or dividend tax rates on dividends – 8.75%, 33.75% or 39.35% for basic-, higher- or additional-rate taxpayers.
Taxes for a sole trader
The combination of corporation tax and further taxes on earnings means that, for many small-business owners, operating through a company leads to a higher tax bill than working as a sole trader. And that has become much more likely in recent years, following increases in both corporation tax and dividend tax rates, as well as reductions in the tax-free dividend allowance. By contrast, income tax rates have been left untouched.
Some small-business experts are worried that the impact of such changes has been poorly understood. They fear that the idea of a company offering greater tax efficiency has become ingrained among entrepreneurs, even though it is no longer the case for many small-business owners. For individual owners, there is no single right answer.
But it does make sense to review your business’s tax position – perhaps after the Budget later this month – to check that you’re not putting yourself at a disadvantage. An accountant can help you analyse the figures under both structures, and then you can consider other advantages and disadvantages. Equally, for new business founders, don’t assume that incorporation is always the right route to go down.
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