One of the many questions people may wrangle with when starting up their own business is whether it is best to be a sole trader or set up as a limited company. So, what are the differences between the two?
There are a number of key differences between each structure, particularly around tax and administrative issues. Making the decision about which structure your business operates under is important, in terms of your future plans, simplicity of your operation, perception of your business and tax considerations. In this article, we aim to give you a clear overview of each, so you can decide which one best suits your personal situation, along with advice on how to set up your business. However, if you are unsure about which structure to choose, it’s advisable to ask an accountant for advice.
What is a sole trader?
Setting up as a sole trader is the easiest and simplest way to set up your business. A sole trader is self-employed and the sole owner of their business. You keep all your business profits after you have paid tax and national insurance on them. You can continue as a sole trader for as long as you wish, regardless of your earnings.
What is a limited company?
A limited company is a type of business structure where the company has a legal identity of its own, separate from its owners (shareholders) and managers (directors). Even if a company only has one person involved with it, they are still a separate legal identity. This means that the company’s finances are separate to yours and you can be paid a salary and/or dividends from the company’s available profits. The company must file annual accounts and make various annual returns to Companies House and HMRC.
Advantages of being a sole trader
- Less paperwork: Sole traders are required to submit a Self-Assessment to HMRC but apart from that there is no additional paperwork to worry about.
- More control: You are 100 per cent in control of your business, with complete flexibility to do as you wish, so you do not have to answer to other directors, shareholders or partners.
- Simpler accounts: Sole traders do not need to prepare formal company accounts. Therefore, the services of an accountant may not be necessary, but if you do decide to use one, the fees should be lower than for a limited company.
- Privacy: As a limited company, you are legally required to share certain information publicly, including stating the names of directors and shareholders on public registers at Companies House, as well as filing annual accounts. As a sole trader, you do not need to declare this information.
- Quick and easy to get started: Setting up as a sole trader is the quickest and easiest way to work for yourself; you simply need to let HMRC know before you start trading.
Disadvantages of being a sole trader
- Unlimited liability: As a sole trader, you are subject to unlimited liability as you are not seen as a separate entity from your business under UK law. This means you could be forced to use personal assets to cover any business debts.
- Could be less tax efficient: Sole traders are generally less tax efficient than limited companies when profits are above a certain level.
- Less attractive to potential clients: Some companies will only work with limited companies and they have a certain prestige that sole traders do not, so as a sole trader it can be hard to create the image of a ‘big business’.
- Harder to secure funding: As a sole trader, it can be harder to secure funding for your business. This could limit your growth potential compared to a limited company.
Advantages of a limited company
- Limited liability: The main advantage of a limited company is that there is a clear legal distinction between the business owners and their business so personal assets are not at risk if the company runs into financial trouble. You only stand to lose the money you put into the company, so this option offers more financial security.
- Potentially more tax efficient: Limited companies are usually more tax efficient when profits exceed a certain amount. This is because they pay Corporation Tax (currently at a rate of 19%) rather than Income Tax on any profits and are able to deduct a wider range of expenses against income than sole traders. In addition, directors of limited companies can pay themselves a mix of salary and/ or dividends that may result in a lower personal tax bill than sole traders.
- Professional status: Businesses that are set up as limited companies generally come across as more professional than sole traders. This can help limited companies access more business opportunities, funding and investment.
- Company name protection: Once you resister your business with Companies House, your company name is protected by law and no one else can use the same name as you. Sole traders are not afforded the same protection.
Disadvantages of a limited company
- Added responsibilities: Directors of limited companies have a number of legal obligations such as filing a yearly confirmation statement and producing an annual set of accounts. These added responsibilities can be time-consuming and costly.
- Less privacy: Unlike sole traders, directors of limited companies are required to publicly disclose their personal details and publish the company’s annual accounts.
Getting started: How to set up your business
Sole trader: Simply contact HMRC and register for Self-Assessment before you commence trading.
Limited company: This is slightly more complex and requires registering your company at Companies House with a number of important details, including the business name and details of directors and shareholders. You can do this yourself, ask an accountant or it can be done through a company formations agent (there is an authorised list of these on the Companies House website), which allows you to complete the registration process online.