Limited Company or Sole Trader?
What's the difference between a sole trader and a limited company?
There are important differences between a sole trader and a limited company.
For sole traders, there is no separation between the self-employed business owner and the business. It is treated as one legal entity. Whereas for a limited companies, the business is treated completely separately from its shareholders and directors, as a distinct legal entity.
A sole trader is responsible for both personal and business debts so personal assets such as a house and car could be a risk if something goes wrong. A limited company’s finances are separate from personal finances so should something go wrong the assets of the shareholders’ or directors’ are protected.
There are more reporting requirements for a limited company vs a sole trader. Sole trader’s have very few reporting demands, typically only amounting to the sole trader’s personal tax return. Limited companies have more stringent reporting and management responsibilities such as registering with Companies House, filing accounts and recording keeping requirements.
Sole trader vs limited company?
There are advantages and disadvantages to being a sole trader or limited company so it is best to consider these from the context of your own circumstances.
Being a sole trader is easier to set up with limited paperwork and reporting, but you might struggle to accessing business finance, benefiting from tax reliefs and protecting personal assets.
A limited company requires more time to setup and some costs and paperwork, however these are not significant and doing so bring advantages such as raising funding, being more tax efficient and protecting personal assets.
Advantages of being a sole trader
Sole trader advantages:
Start now: No need to register with Companies House so you can start as soon as you’re ready.
Easy administration: Only an annual self-assessment tax return is necessary so no need to worry about Corporation Tax or filing company accounts. Record keeping requirements are also very light when compared to limited companies.
More privacy: Your personal and financial information cannot be seen by anyone. Limited companies must disclose certain financial information that is made available publicly depending on the size of the business.
Disadvantages of being a sole trader
Sole trader disadvantages:
Unlimited liability: All the risks associated with running a business and responsibility for its debts rest with the individual. Should the business come into trouble debt providers such as banks can force a sole trader to sell personal assets such as their home.
Less available funding: Accessing finance can be more challenging as a sole trader and is available in smaller amounts. This can slow growth.
Less tax efficient: Sole traders pay 20-45% income tax, compared to 19% corporation tax paid by limited companies. Sole traders are taxed on the profits or losses of the business at personal tax rates.
Less credibility: The sole trader is typically used by smaller businesses and you may be seen as such by your customers using this structure.
Advantages of being a limited company
Limited company advantages:
Limited liability: A limited company is a separate legal entity from shareholders and directors so they are not financially liable for losses or debts of the business.
More tax efficient: Limited companies pay 19% corporation tax so can be more tax efficient when combined with the additional allowances and tax deductible expenses available. Shareholders can withdraw dividends from the business which don’t attract National Insurance and have a lower income tax rate than a salary but remember these profits are after corporation tax. Most owners choose a combination of salary and dividends.
More available funding: Limited companies can access more funding opportunities. Business finance lenders and investors prefer limited companies protection provided by limited liability and tax benefits.
More credibility: A limited company give confidence and trust to suppliers and customers.
Disadvantages of being a limited company
Limited company disadvantages:
More complicated: Limited companies involves more administration and cost. This includes registering with Companies House, filing annual accounts with Companies House, filing company accounts and tax returns to HM Revenue & Customs, following PAYE (Pay as You Earn) procedures and filing a Confirmation Statement to Companies House. Each action typically requires the payment of a fee and the more complex nature of administration means most limited companies use an accountant who specialises in these tasks.
Less privacy: Limited companies have less privacy than unincorporated businesses because the accounts and other documents they file with Companies House are on public record and can be accessed by anyone.
Changing from a sole trader to a limited company?
The sole trader route is often preferred by many small businesses and self-employed people as it’s quick and easy to set up. As your business grows you may decide that it’s time to change to using a limited company structure due to the benefits outlined above
As your business gets larger this decision is easier to make but choosing the right time to make the change can be complex so we would always advise discussing your personal circumstances with a Chartered Accountant.
myfi: accountancy and tax experts offer advice across the UK including Bedfordshire, Buckinghamshire, Cambridgeshire, Greater London, Hertfordshire & Milton Keynes. Talk to us today.