Tax Advice

Sole trader or limited company: Which is best for you?

17 Aug 2021

One of the most important decisions you can make when starting a new business is its legal structure. Should you operate as a sole trader or a limited company? 


The structure you choose will affect many aspects of your business, including your tax position, your personal remuneration, your legal liability and legal responsibilities. 


To help you make an informed decision, this brief guide sets out the main differences between the two business structures: sole trader or limited company. 


However, the decision is not a simple one and many factors can influence your choice, so it may be important to take professional advice on legal and financial implications from a small business specialist like Accounts & Legal

Setting up your business 

The process of setting up as a sole trader is relatively simple. You register your business with HMRC, decide on your accounting period and submit an annual self-assessment tax return. 


If you decide to set up a limited company, you must register the name of your business with Companies House. Registration of the business will also register your company for Corporation Tax at the same time. 


When registration is complete, you will receive a Certificate of Incorporation. You will also need to create a written document known as the Articles of Association and file it with Companies House when you register your company. 


This is a statutory legal document that forms the basis of your company's constitution. It defines your company's share structure and the rights attached to different share classes, details how the company will be governed, outlines rules and protocols for the appointment and removal of company directors and defines the procedures and provisions concerning the sale or transfer of company shares.


Related: How do you loan money to your company?

Employment status and ownership

As a sole trader, you will be a self-employed person and you will own your business. 

If you set up a limited company, you will be a director of the company but you may have to share ownership of the business with other shareholders. 


Although you are a director of a limited company, you are classed as an employee for tax and National Insurance purposes. 

Personal remuneration 

As a sole trader, you can pay yourself a salary from any net profit you make on your business. All of the profits are yours to pay a salary or reinvest funds in the business. 


If you are a director of a limited company you can pay yourself a combination of salary and dividends. As dividends are taxed at a lower rate, this will reduce your tax bill and provide a more tax efficient method of remuneration compared with salary alone. 


There are also other ways to take money out of the business as a director, including bonus payments, pension contributions, directors’ loans and private investments.  We explain these in an article ‘What is the most tax efficient way to extract cash from your business?’.


Related: Taking money out of a business account for personal use

Sole trader or limited company

Pension provision 

It’s important to prepare for your financial future even if you are fully involved in running and growing your business. 


Sole traders must make their own provision by taking out a personal pension and making regular payments, which are eligible for tax relief. They are therefore an efficient way of reducing your tax bill.


In a limited company, you may be able to take advantage of a company pension scheme as well as investing funds in a private personal pension scheme. 

Financial reporting 

Financial reporting is straightforward for sole traders. You submit details of your income and allowable business expenditure on your annual self-assessment tax return. You do not have to prepare or submit full accounts, although it can be useful to prepare them so you have a better understanding of your financial position


Limited companies have to prepare and submit a full set or an abbreviated set of statutory accounts to Companies House in accordance with recognised accounting practice. 


Read More: How To Read A Company Balance Sheet

Taxation of the business 

The financial measure of the success of your business is the profit it makes – the surplus of income over allowable business expenditure. Whether you are a sole trader or director of a limited company, you pay tax on those profits. 

As a sole trader you pay income tax and National Insurance contributions on the profits of your business through an annual self-assessment tax return. To arrive at your taxable profit, you can claim a range of allowable expenses. The rate of income tax and National Insurance contributions is equivalent to that of a private individual and includes the same personal allowances. 


A limited company pays Corporation Tax, which is also based on income minus allowable business expenditure.  However, Corporation Tax rates for smaller businesses are lower than the equivalent income tax rates and companies can claim a wider range of allowable expenditure. 


Don’t forget that, as a director of the company, you may also be liable for personal income tax and National Insurance contributions, depending on the type of remuneration you take. 


Read More: Profit And Loss Forecast Template & Guide

VAT 

If your turnover is greater than £85,000, you must register for VAT and make regular payments to HMRC, regardless of your business structure. 

Personal liability 

One of the most important differences between sole trader and limited company is the scope of personal liability.


As the name suggests, the directors and shareholders of a limited company have limited liability for debts or losses incurred by the company. That means there is no personal liability and less personal financial risk if you form a limited company. 


For a sole trader, the opposite is true. You are personally responsible for any debts or losses and you may have to use your own money to cover any debts. The personal financial risks are therefore much higher. 

Legal liabilities 

Whatever your chosen structure, you have a responsibility to operate your business in accordance with the law. It’s also important to take out certain insurances such as public liability, product liability and professional liability policies to protect your business in the event of legal action


Directors of limited companies have additional responsibilities, known as fiduciary responsibilities. Apart from preparing and filing annual accounts in line with accounting standards, you must also ensure you make decisions in line with the interests of the company, avoid any conflicts of interest and exercise care and due diligence. 


There is also a greater administrative burden for limited companies, which can be time-consuming and distract you from taking the business forward. 

Information about your business

If you run a limited liability company, competitors, lenders and other interested parties can access information about your business from records held at Companies House. 

As a sole trader, your business affairs have greater privacy. 

Business image 

Depending on the nature of your business, clients and prospects may take image into account when assessing you as a supplier.


In general, a limited company would be regarded as a more substantial operation and that may be important if the client is looking for scale of resources and long-term commitment. 

However, if you are a sole trader providing specialist services, size of business may not be important when it comes to winning contracts. 


Lenders may also take the size and image of the company into account when assessing your business for finance. 

Changing business structure 

Although you start your business as a sole trader, you may find there are limitations as your business grows. For example, you may want to access finance for growth, you may want to increase your personal earnings or you may want to reduce personal financial risk — challenges that may be easier to overcome if you are running a limited company.


It is possible to change structure from sole trader to limited company and we have published this article, which explains the options available to you. 

Take professional advice 

Making a decision about the right structure for your business can be complex and must be based on sound business and financial principles. 


If you would like advice on the most suitable structure for your business, our team of experienced small business advisers and accountants will be glad to help. 


To find out more, please contact us on 0207 043 4000  info@accountsandlegal.co.uk Click the link for more tax advice. You can also get a free online accountancy quote here

Chris Barnard

photo

Head Accountant in Brighton

0127380 8000

About the author

Hello there! My name is Chris.

Since graduating with a business degree over 12 years ago I have been helping businesses grow, by sorting their finances and providing great advice. In 2014 I became a Chartered Certified accountant and have worked in various sized accountancy firms, from traditional top 20, to up and coming online accountants.

This resulted in 2015 being recognised in Accountancy Age's 35 under 35 and a year later in 2016 awarded the New Practitioner of Year, at the British Accountancy awards.

I specialise in helping fast growing businesses get a grip with their accounting, tax and financial processes. It can be a minefield, with an endless count of buzzwords and acronyms. 

I help drive efficiencies and business performance through the latest software, and face to face proactive support. Here are a few areas I can help you and your business:

- Help digitise business records in one central location. These are instantly accessible and you'll see a raft of benefits. 

- Deliver and explain business insights on how your business is performing against targets / previous performance

- Create business forecasts to help management cashflow issues or help get funding from a range stakeholders.

- Provide expert tax planning to  companies and individuals to ensure you never receive an unexpected bill from HMRC.

- Access to industry changes and developments before they are live

  

We can help you grasp opportunities

 

If you’re self-employed and thinking of starting a business, we can help plan ahead and get your accounts in order. We are full-service accountants offering tax and accounting support from bookkeeping to business plans, and payroll to tax-efficient investment advice.

 

Call us today or get an instant quote for our services!

 

Instante-Quote-Accounting