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Sole Trader vs Limited Company

Running your own business can be extremely rewarding, but there’s a lot to do before you can even get started.

First things first, you’ll need to set your business up with the correct legal entities and make sure you understand what is required of you to run said business.

One of the most important aspects being; the structure of your business. Which brings us back to the age-old question of Sole Trader vs Limited Company?

These two company structures are actually only two of several, but 9 times out of 10, these are the two that you will be deciding between.

That being said, it’s not the end of the world if you choose one structure, and later find out you’d be better off as another, you can switch any time you please. Just make sure it’s the most efficient course of action.

At A Glance

Registering as a Sole Trader is generally the route you’ll want to take if you’re planning on working alone or on a sub-contractor basis. Whereas a Limited Company is designed for a larger scale operation and future scaling, such as taking on employees.

What Is a Limited Company?

A limited company is a type of business structure and separate legal entity that is limited by shares or by guarantee, that must be incorporated with Companies House.

This general organisation structure separates its assets, income, and liabilities from its directors and shareholders.

Limited companies that are limited by shares are ones who intend to make a profit within their operation. It refers to the shareholders who have a stake in the business by the way of investment.

Limited companies by guarantee are companies that are ‘not for profit’.

Those who operate a limited company separate themselves from the business, it provides involved persons with liability protection and provides efficient tax planning opportunities.

What Is a Sole trader?

Sole traders are individuals that are self-employed and run their own business. This is not a separate legal entity and the individual is responsible for all business liabilities.

Becoming a sole trader is one of the most popular business structures in the UK as it offers a quick and easy setup and low running costs throughout the year.

A sole trader has complete control over their business and keeps all of the profits it makes, but does have unlimited liability, meaning personal assets could be at risk if the business were making a loss.

Why Does It Matter?

Different structures of business have different advantages and disadvantages depending on your current situation. If you’re being careless and don’t think it through, it could actually end up costing you more money.

You’ll also need to inform legal bodies such as HMRC that you’re in business. However, If you are starting up as a sole trader you won’t need to tell HMRC straight away. You have until the 5th of October of the following tax year to declare that you are trading.

limited company office building

For example, if you start trading around Christmas 2020, you won’t need to notify HMRC until 05th October 2021

This, however, is a little different if you decide to register a limited company. A limited company is a completely separate entity to your personal finances and must be shown. In this case, you will need to create your company before you are able to proceed with anything else.

Just from this very first point, you can probably see that sole trader is going to be a lot easier for getting things up and running as quickly as possible; but that doesn’t mean it’s the most tax-efficient.

Income Tax

The most commonly asked question when referring to a sole trader vs limited company is regarding the tax you will need to pay.

The tax you are liable for is different for each structure.

Limited companies are separate entities from the people running them, so individuals are not treated as a whole for tax purposes but instead pay corporation tax on all annual profits; which is charged at 19%.

Whereas sole traders pay Income Tax on all profits, with the addition of class 2 and 4 National Insurance.

Limited companies do, however, have to pay dividend tax on any money they draw out of the business and could also be subject to PAYE and National Insurance if they receive money through a payroll scheme.

VAT

Unfortunately, regardless of whether you are self-employed or registered as a limited company, you must register for VAT if your turnover exceeds £85,000 for the tax year.

VAT is charged on most goods and services at 20%, bar some exceptions that are charged at a reduced rate of 5%, and others that are zero-rated; such as postage.

Expenses

Claiming expenses works the same for both structures of business. The only difference you may notice in expense claims would be for any purchases that are used for business and personal use. More commonly known as “Dual Purchases”

Calculator tax expenses

For example, dual purchases could be anything from motor vehicles to mobile phones. Something you use inside and outside of business operations.

If you are a sole trader, you are treated as, and fall under the rules, of being a business owner. This can differ if you are a director of a limited company, as HMRC could class you as an employee.

HMRC have a general rule you can follow which will allow you to determine the expense more easily.

Authority and Credibility

This is not always the case, but a lot of customers prefer to deal with a limited company in certain industries. It seems to promote a higher level of trust and credibility, giving the customer peace of mind that you are a legitimate, legal entity.

Making a Loss

Sometimes it can happen, your business has a bad year and makes a loss. This happens when your sales are lower than your expenses.

Fortunately, you can use this loss to reduce your taxable income in the same or a different tax year.

When you are registered as a limited company, the business can offset its losses against other income, but not, however, against your income as an individual.

Registering as a sole trader means you can do exactly that, and offset your losses against any other income you have.

Running Costs

With regards to record-keeping and regulatory compliance, a sole trader is generally the cheaper option.

Limited companies are required to process their data differently, such as filing a confirmation statement each year, creating a set of accounts, and submitting the directors’ tax returns.

Annual duties such as filing a ‘confirmation statement’ and a ‘persons of significant control statement’ cost a small fee. Unfortunately, there is no way around this as you are required to keep Companies House up to date with information on your company.

tiny people working on list of expenses on giant screen

Aside from the company itself, the directors also have a number of financial requirements to abide by.

On top of regulatory costs, you’ll also more than likely need an accountant, you may not think you do, but they often pay for themselves with their unique knowledge. They help you make claims and save tax in places you didn’t know you could.

This is going to set you back a little more if you’re operating as a limited company because as you can see, there are more obligations to endure.

Paying Yourself

If you are trading through a limited company it is vital that you do not mix your business with personal affairs. As the company is a separate legal entity the money isn’t technically yours, it belongs to the business.

people holding a pen and writing out a cheque

To draw the money out you can either pay yourself a salary (which will be subject to Tax & NI), or draw out dividends from the business (which is subject to dividend tax). Your accountant will often recommend a tax-efficient mixture of the two.

Operating as a sole trader means you can essentially take money out of the business whenever you please as you pay tax and NIC on all of the profits generated.

Liability

Things don’t always turn out the way you want them to, and with losses, comes debt.

One of the best benefits of working under a limited company is its limited liability. Limited liability will give you financial security to help you sleep safe and sound at night.

A sole trader can face personal liability and could get themselves into debt, as YOU are the business, and so, are liable for any debt the business takes on.

Whereas a director of a limited company will not face any personal liability from the business, and all debts will stay within the company.

This is often one of the biggest turning points in the sole trader vs limited company argument. It all depends on your situation, industry, and a number of factors; which is why it’s important to talk it through.

Advantages of a Sole Trader

  1. Quick and Easy Setup
  2. Low Start-up Costs
  3. Control
  4. Less Administration
  5. Fewer Tax Responsibilities
  6. Privacy
  7. Keep The Profits
  8. Easy To Change Structure
  9. More Personal

Registering as a sole trader; also known as self-employed, has a number of benefits and even less legal responsibility, it could be the better option for a smaller business or contractors.

1. Quick and Easy Setup

Becoming a sole trader is an easy process, you don’t even have to tell HMRC right away, you can start trading immediately. This is because your business isn’t a separate entity, so it doesn’t need to be registered with any legal bodies.

To actually register as a sole trader, all you need to do is inform HMRC; the earlier the better, and let them know you’re self-employed and need to register for Self-Assessment.

man running inside a clock

In case you’re unsure, your Self-Assessment, which you may know as a Tax Return is an annual document that HMRC requires. It’s essentially an overview of your earnings and used to collect Income Tax.

Typically it will show any figures such as pensions, wages, savings, and business income.

You’ll then have to choose your business name, which there are a few rules around, such as not using specific structure marks like “ltd” or “plc”. This name will need to be used for all business functions, such as invoices and other official documents.

As you’re not a limited company, you don’t need to register with Companies House, which does save you a little money in setup costs.

2. Low Start-up Costs

A sole trader has lower setup costs than that of a limited company, in fact, they’re quite minimal.

Registering as self-employed doesn’t have any fees associated with it in terms of HMRC registration. The only costs you may incur are admin fees and accountancy.

3. Control

The term ‘be your own boss’ is thrown around a lot, but operating as a sole trader means you actually are.

You can call the direction of the business and make any financial decisions without consultation (though we recommend discussing important matters with your accountant first).

man holding magnifying glass to approved sign

Having complete control of your company is usually why most people start their own business, they want the freedom to work on their own terms, so it makes sense to enjoy no interference with the decisions you make.

There are no directors or shareholders to consult, you have total control of your entire operation.

4. Less Administration

Along the road of self-employment, you’ll find that it has considerably less paperwork than a limited company. As we mentioned, being a sole trader means you’re not a separate entity from your business, so there won’t be as many legal obligations to abide by.

With any business structure, it is important to keep a record of your business transactions, including any receipts and invoices that you have.

You may need to register for additional services such as VAT, but your accountant will discuss that with you when the time is right.

You’re also not required to report annual business updates such as a confirmation statement, the only paperwork that needs to be submitted is your Tax Return by 31st January each year.

5. Fewer Tax Responsibilities

As a sole trader, there are far fewer legal and tax responsibilities than that of a limited company. You do not need to submit annual documents to Companies House, pay Corporation Tax or submit a set of accounts.

You may have to register for VAT if your annual turnover exceeds £85,000 but aside from that, you only need to file your Self-Assessment Tax Return once a year.

6. Privacy

Being self-employed means your business affairs remain private. There is no way any member of the public can gain access to your documents or see how much money you’ve made/lost in financial periods.

cartoon police man standing next to giant phone with security and privacy data

With limited companies’ certain information is public on Companies House; such as your set of accounts, confirmation statements and some directors information, these are stored on their central database and can be accessed online and viewed by anyone with an internet connection, resulting in a more open company record.

This may not be a problem for some, but for others, it’s a preference.

You do have to submit a Self-Assessment Tax Return each year, but this won’t be available on public record.

Not having to register as a director also means your private and personal information won’t be visible on Companies House either.

Per HMRC’s taxpayer confidentiality rules, your private information will remain private as a sole trader, so personal friends and competitors alike, won’t be able to gather more information on you or your business.

7. Keep The Profits

One of the most enticing incentives to operate as a sole trader is that you get to keep all the profits you make.

You don’t need to share them with investors, other directors, or shareholders as you would in a limited company or partnership.

Profits can be maximised and it’s up to you to keep the costs low. Everything you make as a sole trader is yours to keep.

8. Easy To Change Structure

Operating as a sole trader allows a lot of flexibility in terms of business structure. It makes it easy to switch to another at a later date.

cartoon women sitting at desk thinking

This allows you to keep an open mind about future possibilities and plan for opportunities.

For example, if you find your business drawing in more income, it may be more tax-efficient for you to register as a limited company going forward. You can do this through a reasonably straightforward process.

Unlike the process, if you were to reverse the situation, and go from a limited company to a sole trader. This is a little more complicated and involves dissolving your business and stepping down as a director.

It may also be beneficial for you to start as a sole trader to ‘test the waters’ so to speak. It’s easy to set up and there are very low setup costs, giving you the opportunity to decide on future endeavours without too much commitment.

9. More Personal

Depending on the industry or sector your business plans to work within, it could be beneficial for you to operate as a sole trader. This will give you the chance to offer a more personal touch to your customers, and make use of its ability to provide a personal service.

It’s not easy for limited companies to create a personal touch around their brand and offer character, something a customer could desperately be looking for depending on your line of work.

If you can offer that to a customer, you could stand out from the rest of your competition.

Disadvantages of a Sole Trader

  1. Unlimited Liability
  2. Difficult To Raise Finances
  3. Tax Planning Limitations
  4. Larger Responsibility
  5. Lower Credibility
  6. No Business Name Protection
  7. Difficult to Sell Your Business

Though there are a number of benefits to being a sole trader, there are also some drawbacks to be aware of. Including taking on a lot of risk within your business.

1. Unlimited Liability

The biggest downside to operating as a sole trader is its unlimited liability. As the business is not registered with Companies House, and therefore not a separate legal entity, any debt that the business incurs is liable by you.

This means there is no protection of your personal assets, thus producing more risk for sole traders.

cartoon man falling into debt

It’s great not sharing your profits with anyone, but it also means you can’t share the debts either.

If the business was to take on a lot of debt; such as outstanding tax, or rent, this would be collected via the owners’ personal items. In worst-case scenarios, this could be items such as your vehicles and property and even personal bankruptcy.

Of course, any assets inside the business can be used to pay off the debt first.

2. Difficult To Raise Finances

Following on from the above point of unlimited liability, it can be difficult for your business to raise finance for this very reason.

lady thinking and confused

Banks tend to scrutinise sole traders because of the risk associated with the loan. This often means that you can’t get access to more advantageous finance and loan options that you would if you were registered as a limited company.

You’ll have to come up with a very convincing business plan for better rates.

Banks are also put off by the lack of transparency that is involved with a sole trader, as there are no annual accounts available for them to look over.

In some cases, people look to other individuals for financing, such as an investor, but without shares available to offer to these investors, it can be difficult to get them on board.

3. Tax Planning Limitations

As all of your income is subject to Income Tax (less your personal allowance) at the end of the financial year, it is difficult to plan for tax-saving opportunities.

With a limited company you are able to leave some money in the business and pay yourself further down the line, or through dividends. As a sole trader, you can’t re-invest your money back into the business through retained profits.

This is why it is usually more tax-efficient to operate as a limited company.

Sole traders have the same tax status as individuals. You are credited with a tax-free personal allowance which currently stands at £12,570 for the 2021/2022 tax year. Any income received above this figure is subject to income tax, which currently stands at 20%. This is further increased to 40% for higher rate taxpayers for income above £50,271, and 45% for anything above £150,000.

Remember National Insurance is also due too.

4. Larger Responsibility

Although being your own boss and running a business is an exciting venture, it can also be quite daunting. You have the sole responsibility of making decisions and creating an actionable plan for the success of your business.

cartoon people responsible for putting together large jigsaw

This means the future of your business is resting on your shoulders alone. That’s why it’s important to have someone in your back pocket to help guide you along.

You’ll also find yourself wearing multiple hats. This means you’ll be running all aspects of your business, not just the sales.

As a sole trader, you are more likely to work longer hours to get everything done, you can’t rely on others to bring in the sales or complete admin work. This also means that if you’re sick or needs some time away from work, you won’t get paid, there is no SSP in place if you’re unable to work, which could result in loss of income.

5. Lower Credibility

Though we discussed earlier the advantages of having a more personal approach as a sole trader, it can also swing the other way.

If you’re dealing with larger suppliers or even a large number of customers, a sole trader can give off a slightly unpredictable vibe.

It doesn’t always create the most professional image nor attract a lot of clients.

Having a limited company comes with a reputational value, they are often perceived as a more reliable and trustworthy business to be associated with.

It’s worth looking at your industry and figuring out what your client base will be, and deciding whether your company image matters to your target audience.

6. No Business Name Protection

cartoon women sitting at desk stressed

When working as a sole trader, your business name has no protection. Anyone can set up a business and use the same name with no consequences.

This could prove difficult if someone is operating a business with a similar, or even the same name as you, you could end up fighting between clients and reputation.

Plus, it makes it increasingly difficult to create a brand image for yourself, if you’re always at risk of someone copying your business identity.

If you’re registered as a limited company, your business name will be registered with Companies House, and no one else can use it; or in fact, any that is “too similar“.

7. Difficult to Sell Your Business

If you ever plan to sell your business in the future; which I know, is a difficult thing to consider before you’ve even got started, it can cause problems if you’re a sole trader.

It’s not as easy as just “selling your business”, as in this case, it’s not a separate legal entity. This means you will need to transfer assets over to the new owner individually.

Advantages of a Limited Company

  1. You Pay Less Tax
  2. Limited Liability
  3. Increased Credibility
  4. Easier To Access Funding
  5. Opportunity For Tax Planning
  6. Business Name Protection
  7. Opportunity For a Pension
  8. Easier To Sell

A limited company is also a popular legal structure in the UK due to its many financial efficiencies.

It does, however, involve a more complex process of incorporation in addition to more administrative responsibilities.

Just as with a sole trader, whether or not it is right for you, depends on your business situation and future plans.

1. You Pay Less Tax

A limited company is much more tax-efficient than that of a sole trader over a certain level of income. Not only is it able to successfully tax plan for its future, but it actually allows you to pay less personal tax than if you were self-employed.

cartoon man sitting at desk celebrating paying lower tax

Most directors take a small salary through a payroll scheme that their company operates, in addition to drawing money in the form of dividends. Which in turn, means you can take home more pay as a limited company.

They do this as it allows you to minimise your National Insurance contributions throughout the tax year.

Sole traders are required to pay between 20% and 40% income tax on profits above their personal allowance, whereas limited companies only need to pay 19% corporation tax. Which again, allows for greater opportunity in tax-planning

2. Limited Liability

As a limited company, your business is a separate legal entity from the people running it, meaning any debt that the business incurs, stays within the business.

No directors are liable for debt outside of the business, so your personal assets are safe, and not at risk as they would be with self-employment.

If your business was to become insolvent, its shareholders are only liable for the nominal value of the unpaid shares they hold.

Depending on the line of work you’re in, it could be extremely beneficial to be protected against any legal action.

3. Increased Credibility

Operating as a limited company could give your business more credibility. Many people prefer to work with established brands that have a trusting image.

two cartoon business men shaking hands and making deal

It often inspires confidence in your brand and opens many doors as most businesses choose not to deal with sole traders due to their lack of transparency.

With the obligation of annual accounts, confirmation statements and other financial documents, limited companies can seem like they are monitored a lot closer than sole traders.

Their records are public and their business is operating with complete transparency for anyone to see.

This coupled with a professional image can benefit your business when dealing with not just customers, but suppliers and investors too.

4. Easier To Access Funding

With its increased transparency and public records, banks tend to offer more appropriate financing to limited companies.

It’s less difficult to obtain a loan from the banks and also easier to attract investors.

Limited companies are able to offer shares in exchange for funding, this often provides an appealing offer to investors.

5. Opportunity For Tax Planning

Having a limited company means that you can control your finances much, easier using tax planning to maximise your income and minimise your expenses.

It gives you the opportunity to reinvest cash back into your business until you’re ready to withdraw it, so you don’t have to pay tax on everything straight away.

cartoon hands on whiteboard tax planning

You can also do the same with any losses your limited company makes. These can be used to offset forthcoming liabilities, in the same or future tax periods.

You can also defer the withdrawal of personal takings such as dividends to a later period of time. For example, when your personal allowances or dividend allowance renews.

6. Business Name Protection

Unlike sole traders, limited companies have complete protection over their business name. As it is a separate entity, your business has to be registered with Companies House.

This means that your name and other business information is also registered, and so, your company name is legally protected.

Companies House will not allow anyone else to register a business in the UK with the same name, or even one that is too similar.

7. Opportunity For a Pension

cartoon elderly man enjoying retirement lying on beach chair

Limited companies provide the ability to invest income into a company pension scheme.

This supplies a substantial advantage over sole traders as you can plan for your future and save money ready for your retirement.

Investments into pension schemes are also an allowable expense; which will reduce your business’s tax liability.

8. Easier To Sell

Selling your business is much easier when you’re operating as a limited company. You can transfer your shares to someone else quickly due to how they are structured.

It can prove a little more difficult if there are other directors and shareholders within the company, but as it’s a separate legal entity, it’s still much more painless than if you were trying to sell your business as a sole trader.

Disadvantages of a Limited Company

  1. Complicated Setup
  2. More Admin Work
  3. Accountancy Costs
  4. Less Privacy
  5. Problems With Decision Making
  6. Strict Record Keeping

With its great benefits, running a limited company also has its downsides. There’s a lot more admin work involved in running your business and more work required in terms of legal obligations, which could result in higher accountancy fees.

1. Complicated Setup

A limited company is a little more complicated to set up than a sole trader, you can’t just decide to start trading right away.

Your business will need to be registered with Companies House, which means paying a small company formation fee.

business man confused with different directions

You’ll also have to make sure your business name isn’t registered with another company. Which are subject to certain restrictions and rules.

These are not necessarily difficult tasks, but the whole process is a little more time-consuming.

2. More Admin Work

With a limited company, you must file a set of accounts each year with Companies House, which will appear on public record.

You will also need to provide HMRC with Corporation Tax calculations on an annual basis.

cartoon lady burnt out at desk

To make sure your set of accounts is accurate and easy for your accountant to take control of, you will be required to keep any financial information on a regular basis.

This will be used not only for your company accounts but also for your directors’ Tax Returns.

A limited company set of accounts can be quite complicated to complete, and usually require the help of a professional, especially if you plan on being the most tax-efficient you possibly can.

On top of all this, you are legally obligated to provide Companies House with a Confirmation Statement on an annual basis, this is simply a document that updates their records with your latest business information, and also costs a small fee to submit each year.

3. Accountancy Costs

We always advise that you hire yourself an accountant. Good ones will almost certainly pay for themselves with the expert advice and tax planning they offer.

Running a limited company, however, does mean higher fees, this is due to the nature of work involved.

As you now know, you are required to submit annual accounts, confirmation statements, tax returns and more throughout each financial tax year.

This isn’t really something you can afford to avoid. Missing a deadline or filing a document incorrectly can result in penalties.

4. Less Privacy

Limited companies have much less privacy than that of a sole trader. Once you submit your information and register your business, that information is available on Companies House for public viewing.

business team using binoculars and spying

Your annual accounts and directors information will also be available for the world to see. This can be beneficial for your business in some ways, as it helps secure funding; but this doesn’t suit everyone.

Your friends, old co-workers, or even competitors can check up on your business to see how you’re doing.

As the directors’ and business information is on Companies house, your registered address will also be visible. If you’re working from home this could mean your private address is online.

There is, however, a way around this. If you hire an accountant to look after your limited company, they will use their office as your registered address, and instead, this will show up on Companies House records.

5. Problems With Decision Making

Limited companies are likely to have directors and shareholders, both of which, have a say in how the business operates. This could cause friction for future planning if two directors/shareholders have trouble agreeing on a direction.

With multiple shareholders and directors on board, all of their opinions need to be taken into account before you can make a decision. At times this can feel like you don’t have control of your business, so be prepared to share the responsibility.

6. Strict Record Keeping

As a limited company, you are required to keep regular and accurate records of business operations.

Aside from the usual records of financial transactions, such as invoices and receipts, a limited company must keep details of its company directors, shareholders, loans, and other important documentation regarding business operations.

You can find a full list of the records you are required to keep on HMRC. If you make any changes to your business or its directors, you must notify HMRC immediately.

Conclusion

Unfortunately, there is no definitive answer to decide on which route is most suitable without getting a professional to look over your plan, as a lot of advantages and disadvantages for both are situational.

Most accountants offer a free consultation for exactly that; and will discuss your options and what’s best for you.

It’s also worth mentioning that just because you’ve started as a sole trader, for example, doesn’t mean that it won’t be more tax-efficient for you to change the structure in the future.

One Reply to “Sole Trader vs Limited Company”

  1. Great article thanks for sharing! Really gave me some good ideas going forward, hoping to start a business soon and this is just what I needed

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