Sole Trader Vs Limited Company

When starting a new business you need to decide to become either a sole trader or limited company. How you decide to register and structure your company depends on your type of business, where you work and whether you need to employ people. 

Sole Trader vs Limited Company

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Check out our guide to help you decide what would suit your business, covering the pros and cons of each option and the factors you should consider before deciding whether to become a sole trader or limited company.

What is a Sole Trader?

A sole trader is a self-employed person with only 1 owner and is a popular business structure in the UK for a number of reasons.

Advantages of being a Sole Trader:

Less Administration

Sole traders have less administrative requirements and only have to file a  Self Assessment Tax Return. There is no requirement to appoint directors, allot shares, and file multiple records with HMRC.

Autonomy

Sole traders have complete control over the business and can dictate the direction of their business. without interference any other Directors.

Ownership of Profits

Sole traders can keep all profits after tax. Unlike limited companies, sole traders don’t have to split profits or pay shareholders.  Sole traders can maximise profit by having sole control over costs.

Low Start Up Costs

As a sole trader you have less legal requirements to set up. You do not have to register at Companies House or pay an incorporation fee.

Privacy

As a sole trader your business records are not made public. As a limited company you are required to register as a director and this information is available from Companies House for public inspection.

Personal brand

Depending on the nature of your business you may decide that a personal brand rather than a corporate image would suit your target clients best.  Businesses proving local services may build more local support as a sole trader. 

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Disadvantages of being a Sole Trader:

No legal separation

As a sole trader you are legally not separated from your business. Sole traders are personally responsible for any losses a business makes.  You have ‘unlimited liability’ as a sole trader which means you are legally responsible for any debts, losses, and liabilities so your personal assets, (this includes your home and savings) could be seized to pay creditors if you were unable to meet your financial obligations or if legal action was taken against your business.

Investment

Soles traders can find it more difficult to attract investment and may have change their business structure to an LLP to seek investment.  Without being able to offer shares in the business to raise capital sole traders are restricted to seeking funding from banks and similar lenders.

Brand Identity

Sole traders are not always perceived to be as credible or professional as a limited company making it difficult to attract larger clients and grow your business.

Tax Restrictions

As a sole trader you pay income tax above £12,500 (as at 2020), after you have reached this personal allowance limit you pay 20% on income between £12,500 and £37,500, 40% on income between £37,501 and £150,000 and 45% for income above £150,000. 

What is a Limited Company?

A limited company is a popular legal structure in the UK as it offers many benefits that are not available to sole traders. The status ensures that the liability of company directors and shareholders is limited to their stake in the company.

Advantages of being a Limited Company:

Limited Liability

When you incorporate a company you and your business become separate legal entities.  As a limited company you are not personally liable for the company’s debts.  Any debt, losses, or legal claims associated with the company are the responsibility of the company not the directors, shareholders or owners – personal assets such as your home or car are protected.  

If your business provides high-value products or services that could result in liability claims then choosing to structure your business as a limited company may be the appropriate option for you.

Tax Relief

Limited companies have a wider range of allowances and tax-deductible costs they can claim against profits which will reduce your corporation tax liability . As a limited company you can claim tax relief on expenses such as pension contributions, childcare vouchers, business equipment and business travel.   When allowable expenses are claimed you reduce the amount you need to take from your company in dividends.

Tax Planning

Sole traders pay income tax above £12,500 between 20-45%.  Limited companies pay only 19% corporation tax on profits which enables greater flexibility for tax planning. If you have a successful year you can reinvest your profits rather than paying personal tax in addition to corporation tax – this will benefit your business in future years when your business may require funding which you would have already paid tax on only to reinvest back into the business.  As a limited company you can also opt to defer personal income if available profits would take you into a higher income tax or dividend tax bracket in any given year.

Flexible Personal Income Options

Depending on your business turnover you may be able to increase your personal income by reducing  tax when operating as a limited company.  As a director you are able to take a combination of salary and dividends. If your salary is below the national insurance contributions lower limit you will not have to income tax or national insurance on these earnings – the remaining income can be paid in dividends (assuming your business made a profit) - you are not required to pay tax on the first £2,000 of dividend income and the rates over £2000 are considerably lower than income tax.

Professional Status

As a limited company your business is more likely to benefit from the perception of having a professional status. Some businesses will only work with registered limited companies rather than sole traders.

Investment Opportunities

As a limited company it is easier to attract funding -  potential investors will be confident that there are more rigorous checks on a registered business and be more likely to invest.  As a limited company you can raise additional capital by selling shares in the business.  It is also easier to secure a loan for a company as a limited company without the need for personal security against personal assets. By having strong investment opportunities, a business is in a better position to grow and is not restricted by the difficulties a sole trader may face attracting funding.

Brand Identity

As a limited company you must register a business name  -  no two companies can be set up with the same name so your business name and brand identity is protected. Sole trader’s are unable to protect their name in this manner. Another sole trader in the same area as you could set up a business using the same name and benefit from the brand identity you have built.

Disadvantages of being a Limited Company:

Administrative Duties

As a limited company you have a requirement to file a number of accounting documents, this means you will need to invest more time and resources preparing and filing additional records. This includes taking minutes of meetings and recording all decisions taken by directors and shareholders Most directors will still be required to file a Tax Return with HMRC in addition to the legally required documents:  

To reduce your time spent on administrative duties most Limited Companies will appoint an accountant to manage their accounts and submit them to HMRC.

Legal Duties

As the director of a limited company, you will have legal duties to fulfil. If you are found to have neglected your legal duties you can be personally fined or in serious situations even go to prison.

Your duties as company director include safeguarding the company’s assets and making the decision to cease trading (go into administration) if you know the company is insolvent.

Register As An Employer

If you are employed by the company as a director or you have any employees, you will need register the company as an employer and set up a payroll.

Privacy

As a Limited Company your company’s accounts and confirmation statement are available on public record.

Tax Implications

As a sole trader you are able to draw money freely out of your business bank account.  As a director of a limited company you are permitted to claim dividends on the shares you own, and claim legitimate businesses expenses however if you draw money out of the company for any other reason you may have to pay extra tax.

Deciding to be a Sole Trader Or Limited Company

There are many things to consider when it comes to deciding whether or not to incorporate your business.  Either structure comes with its own set of advantages and disadvantages as we have discussed above.  Every business is different and your personal circumstances, size of business, industry and plans for growth may be a guide to your decision. 

 

At Styles & Associates we provide professional advice tailored to your business objectives and long-term plans and can help assess the most appropriate business structure for you.

 

Whether you decide to become a Sole Trader or a Limited Company let us help get you started on the right track.

Sole Trader Vs Limited Company

Moving our business to Styles & Associates made savings for us on our accounting fees, corporation tax, and personal tax.

Gareth Wilding