Freelance Ltd: The self-employed who aren’t

Coronavirus support for the self-employed has shone a light on freelancers who run their business as a limited company.

The support for businesses, the self-employed and employees during the coronavirus outbreak is staggering, but there are large numbers of people who fall through the cracks.

After the Chancellor’s announcement of support for the self-employed, two groups immediately spring to mind: those without a full year of accounts and individuals who run their business through a limited company.

There are 3.5 million sole proprietorships (a company with only one director) in the UK – that’s 59% of all businesses. Many of these people would consider themselves to be self-employed or freelancers, but are they?

According to GOV.UK:

A person is self-employed if they run their business for themselves and take responsibility for its success or failure.

Self-employed workers aren’t paid through PAYE, and they don’t have the employment rights and responsibilities of employees.

So, where does a sole proprietor running a limited company fit into that? They run their own business and take responsibility for its success/failure, yet receive income through both PAYE and dividends.

A career trajectory

Many self-employed people start as a sole trader then become a limited company. There are two principal reasons to go limited:

  1. It puts a legal barrier between the individual and the business
  2. In many sectors, clients won’t work with sole traders

At certain income brackets, there are also some tax benefits to going limited, but we’ll get to that.

For many freelancers, the legal separation is key. It’s the same reason they buy professional indemnity insurance: if something untoward were to happen, they don’t want to be in a position where they might lose their house – and rightly so.

Sole proprietor income structure

The way many (most? all?) sole proprietors receive their income is through a mix of PAYE and dividends.

Typically, they receive their tax-free allowance through PAYE (about £12,500), then the rest of their income as a dividend. Dividends above £2,000 are taxed at 7.5%, which jumps to 32.5% above £50,000.

There is also a corporation tax (19%) on profits.

According to Contractor Calculator, for the £14,500–£50,000 income range, employees pay around 7% more tax than sole proprietors. For all other income ranges, sole proprietors pay more.

This 7% is the cause of much contention: they’re all tax dodgers! But are they?

For those who earn under £50,000 – the limit for Government coronavirus self-employed support and any financial advantage of incorporating – there is a practical barrier to declaring a representative regular monthly income: cash flow.

Anyone in this bracket is likely to have months where their business earns a lot and months where it earns comparatively little. Adjusting pay through dividends is a simple way to make sure there’s enough money to cover ongoing business costs, which might include paying other contractors/sole traders.

Guaranteeing the business has enough money to cover the monthly PAYE of the director’s representative salary requires that the turnover/profit is significantly higher than their wage. For many sole proprietors, there simply isn’t the financial buffer in the business to do this.

Alternative wage arrangements

If we imagine that cash flow isn’t an issue, an alternative would be for sole proprietors to take their wages exclusively through PAYE or dividends.

Receiving income entirely through dividends produces an income tax rate of around 26% (19% corporation tax + 7.5% tax on dividends over £2,000). This is slightly higher than a combined PAYE/dividend approach but would make them ineligible for any coronavirus support – more on this later.

If wages were paid entirely through PAYE, the income tax rate would be the same as an employee, plus an employer’s National Insurance contribution of 13.8%. This is taken on top of the salary, so if they withdrew 100% of the company’s profit, they would need to reduce their salary by 13.8% to prevent the company recording a loss.

For incomes up to the £50,000 limit, this creates a disparity in take-home pay. It’s around 7% higher than an employee or 10% higher than a sole trader. Any remaining profits also receive the corporation tax at 19%.

This is about as close to a direct comparison as it’s possible to get, but it’s clear that a sole proprieter drawing the ‘equivalent’ employee PAYE salary has a much higher tax bill than either an employee or a sole trader.

Are these additional taxes a fair price for establishing a legal separation between a person and their business? How about freelancers who need to incorporate to secure work?

Sole proprietors taking wages through a combination of PAYE and dividends isn’t about some great tax dodge, it’s the closest way to achieve tax parity with an employee.

If this isn’t considered fair, the rate of tax on dividends below £50,000 could be increased to bring directors and employees into line: a policy that’s unlikely to be popular with shareholders in larger businesses.

We haven’t even talked about the other costs that a sole proprietor would need to fund:

  • Sick pay
  • Maternity/paternity pay
  • Holiday pay
  • Pension (employer matched‽)

Sole traders will be familiar with the lack of support in these areas, and they don’t disappear when a sole trader incorporates. These must account for at least some of the 7% disparity between a sole proprietor’s PAYE/dividend income and that of an employee.

Falling through the cracks

The discrepancy in tax contributions between sole traders and sole proprietors is small: a couple of percent in the £14,500–£50,000 income bracket. Yet, sole proprietors have been omitted from support in the coronavirus package, despite the Chancellor repeatedly stating that the self-employed “would not be left behind”.

The GOV.UK page outlining the new support for the self-employed (read: sole traders and partnerships) reads:

Those who pay themselves a salary and dividends through their own company are not covered by the scheme but will be covered for their salary by the Coronavirus Job Retention Scheme if they are operating PAYE schemes.

This is difficult for sole proprietors for a few reasons.

Firstly, for the reasons listed above, it would be difficult for their PAYE income to be truly representative of their wages.

The second issue is that it’s tricky for a sole proprietor to furlough themselves as required by the Coronavirus Job Retention Scheme. Though technically possible, furloughing an employee requires them not to work: for sole proprietorships that means the business stops operating.

This is a key difference with the self-employed scheme, where sole traders are allowed to continue working.

In practice, this only benefits businesses that have lost all trade. Many businesses will have been adversely affected by the coronavirus, but not to the point where they need to shut down completely.

For any business with employees – 99.9% of all businesses have 0–249 employees – that could put the business in jeopardy, at which point guaranteeing employee wages may be a moot point.

IPSE, one of the bodies that worked with the Chancellor on the self-employed package, did a great job of putting the case of sole traders to the Government. Andy Chamberlain (Policy Director at IPSE), explained the rationale for the exclusion of sole proprietors in a series of tweets.

The Chancellor argued that dividends wouldn’t be replaced as they are “primarily a return on investments”. This would be true if sole proprietors were investing in their businesses, but they’re not: they are working for that money.

It seems this issue wasn’t pushed harder in order to strengthen the argument against IR35: a policy the Government seems determined to push through. For many sole proprietors, this is likely to be a hard pill to swallow, especially for any businesses already under IR35 or those who won’t be impacted.

Self-employed or not?

After all of this, we’re left with two basic questions:

  1. Sole proprietors pay a similar level of tax to sole traders at the income bracket available for financial support. Does that small discrepancy make them ineligible for comparative support?
  2. Does someone really stop being self-employed the moment they become a limited company? Even when they’re the only person in the business?

For the time being, the answer to both of these questions seems to be yes. It’s no wonder that many sole proprietors feel left out in the cold.


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