I'm opening my own restaurant and am undecided whether to set up as a sole trader or as a limited company. Which is the best option?
Andrew Burnham, MacIntyre Hudson
Restaurateurs have often opted for a limited company as their business vehicle, but each circumstance needs careful consideration. Do nothing else and your tax status will be that of a sole trader. So the key issue is whether incorporation as a limited company is appropriate.
- The liability of a shareholder is limited to the amount of cash paid for shares. As a sole trader, you have unlimited personal liability for all business debts.
- Succession planning and tax planning for owners, potential investors and employees may be carried out more easily through a limited company.
- Companies pay dividends, free of national insurance (NI) contributions.
- Accounting records must be maintained in accordance with the Companies Act, and annual accounts must be filed.
- Larger companies may require an audit - an additional cost.
There is an element of double taxation. Company profits are taxed, and dividends paid out of post-tax profits are then liable to further tax when in the hands of the recipient. Other amounts will have tax consequences, often involving 12.8% NI (payable by the company), in addition to the tax paid by the individual. A sole trader will be taxed on profits alone and can draw money freely.
There is another option - limited liability partnership. This provides limited liability but with the taxation profile of a sole trader, although this does require a partnership to be formed with another party.
Professional advice should be taken in each case - a wrong decision can be costly. For further information see
Paul Thompson, Acorn Commercial Finance
One of the main reasons for opting to trade as a limited company would be that your restaurant is projecting a large trade and high levels of profit, which will be used to grow the first outlet and open more. Then, corporation tax at 19% is preferable to income tax, which may well be at 40%.
In cases where the finance deal is regulated by the Financial Services Authority (FSA), use of a limited company removes this regulatory burden. Some lenders in the commercial market will not offer a loan when the case falls under FSA regulation.
In the past, it was the case that a limited liability company protected its directors and shareholders from creditors in the case of bankruptcy, but in most cases nowadays any lender would expect a guarantee from any director holding more than, say, 20% of the shares.
Where these issues are not a major factor, the ease of setting up as a sole trader or partnership might be preferable. A sole trader need not have audited accounts produced, and does not have to register and complete returns to Companies House, saving time and money.
Since you own the business as a sole trader, in some cases it's easier to dispose of the restaurant in the future. If the limited company sells its asset (the restaurant), the money is effectively locked up within the company and withdrawal might incur a significant tax liability.
As profits are effectively the earnings of the sole trader, it becomes easier to withdraw money from the business.
Ashley de Safrin, Business Link for London Setting up a restaurant is more complex than some businesses. The set-up costs are high because of the high cost of premises, equipment and staff.
While being a sole trader has its advantages, forming a limited company is the best option for a restaurateur, as liability is usually limited to the amount you invest in the company by buying its shares.
Although setting up as a sole trader is simpler and quicker (you need to keep only basic accounts), being a sole trader can have serious financial implications, as you are personally liable for all debts. With a limited company, if the business goes into liquidation, the creditors are paid out of the sale of the assets.
Under normal circumstances creditors have no legal right to obtain repayment from the directors or other shareholders of the business. In addition, the debts of the company should not affect the directors' personal credit ratings.
Other advantages of forming a limited company include raising money more easily for expansion, and possible tax advantages for high earners by keeping money in the business or making pension payments.
Forming a limited company is not without its disadvantages, however. Annual accounts are generally more complicated, and once your turnover climbs above £5.6m, an independent audit is compulsory - however, few independent restaurants reach that level. National insurance payments are also higher and you will have to pay employer's as well as employees' NI contributions on salaries.
Overall, the benefits of being a limited company far exceed those of setting up as a sole trader, because it gives you the option to grow your business easily if you choose to do so.