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Sole trader vs limited company:
what's the difference?

When you are starting out as a business there are lot of decisions to be made – one of the most important is to decide whether to setup as a limited company or sole trader. It’s important to understand what they both mean and which structure is more suitable for your circumstances.

Sole trader

This is the most straightforward way for many freelancers or contractors to begin their career as all that is required is to register with HMRC as self-employed within 3 months of trading and then pay National Insurance and Income tax. This structure requires minimum administration and involves submitting a self-assessment tax return every year. Hence, it’s more popular amongst contractors or traders engaged in construction, plumbing, electricians and transport.

Sole trader structure is usually less tax efficient as the individual is the business and hence pays personal tax on the income generated. Further, there is no legal distinction between the personal and business finances, implying personal assets can be considered to settle business liabilities like debts or loans.

Limited Company

Limited company on the other hand is the most tax efficient way to trade and minimise personal liability. Limited company is considered as a separate legal entity from the owner and hence the liability is limited, implying they’re not personally responsible for any liabilities incurred by the company.

The below table summarises the fundamental differences between both the structures

Comparatives Sole Trader Limited Company
  Administration  Low Administration.
There are less statutory obligations. 
High Administration.
There are greater statutory obligations as a Director. 
Liability   You are personally liable for your own finances and possessions may be at risk if things go wrong.  You are treated as separate from your limited company; you are protected (provided you meet your statutory responsibilities as a director) from the threat of personal financial losses if things go wrong. 
Costs and Accounting   Setup cost involved is low and the paperwork is very simple as there is no requirement to register your business at Companies House. You only need to inform HMRC within 3 months of trading. Also, accounting is simple and less costly.  Setup cost is high as various registrations are required with Companies House and HMRC. Moreover, because of a range of statutory obligations accountancy cost is usually higher. 
Status   Some companies look more favourably towards limited companies and recruiters typically will not engage with Sole Traders.  Some companies view a limited company in a more positive manner. Larger companies may refuse to transact with anything other than a limited company. 
Tax Planning   Limited scope for tax planning. There are tax planning opportunities like spousal dividend planning, timing of dividends etc. giving you more flexibility hence tax savings
Confidentiality   Information is kept private and confidential and is not available to the public as opposed to a limited company All information like Director’s details, annual accounts and companies trade is publicly accessible.

How do I set up as a sole trader?

The process to becoming a sole trader is simple with less paperwork and cost. When you decide on the name you will need to inform the HMRC that you’re self employed and register for self assessment, make sure you have a National Insurance number.

How do I set up a limited company?

After deciding whether you will be a private limited company or public (read more on the differences and benefits) you must pick a company name and register at the Companies House by post or online.

Where does the liability for my sole trader business lie?

Sole traders lack a legal distinction between them and the business so they are personally liable for every decision made, profits, or debts.

Where does the liability for my limited company lie?

Business liabilities in this structure remain separate from the individual.

How do I pay tax as a sole trader?

At the end of each tax year a sole trader must submit self assessment tax return and pay National Insurance to HMRC to avoid penalties.

How do I pay tax as a limited company?

As a limited company you are only subject to Corporation Tax on your profits and not Income Tax or National Insurance but you will have different deadlines set for you by HMRC and Companies House.

Deadlines

When you incorporate your business at Companies House your given an accounting reference date where the first date is the last day of the month for the incorporations first year anniversary it can also help you identify the end of the financial year for your business.

Corporation Tax

You are required to pay this tax out of your profits and must be paid within nine months after your accounting period ends to avoid making two payment deadlines in your first year.

CT600

The CT600 form can be obtained from HMRC yearly and should be filled with information of your company’s income, business expenses and minus tax allowances.

P11D

Directors of limited companies and individuals who direct a company on their own must fill and submit P11D forms to HMRC to sum up the value of benefits and expenses made to directors and employees.

Year-end accounts

Your business must make available year end accounts to the public through Companies House after the end of your accounting period. The account must include a statement of financial position, income statement, and other relevant company accounting notes.

VAT return

A limited company should add up the VAT added to their sales and make VAT deductions paid on business expenses at the end of every quarter.

Self-assessment

On 31st January of each year you are required to file a self assessment showing all income gained from your employment, any dividends paid to you by you from your company other sources of income that you may have.

How do I pay myself a salary as a sole trader?

Because you still have to do self assessment tax return withdraws that you make for personal use out of your business income should be seen as a salary worth reporting on. The advantage for you is that you can cash out any time.

How do I pay myself a salary as a limited company?

For personal payment as a director you pay yourself through a PAYE salary but don’t forget to keep reporting your income correctly to HMRC to avoid penalties.

Who is legally responsible for my sole trader business?

Since the person is the business, a sole trader is legally liable for any legal issues or disputes that involve the business. If your company is in trouble or has been sued you are personally responsible in fixing the matter and paying off any costs.

Who is legally responsible for my limited company?

Any limited company director is legally responsible for their company and held to higher standards of conduct than other employees. Directors are also obliged by law to follow to the Director’s Fiduciary Responsibilities.

How do I claim business expenses as a sole trader?

To claim for tax relief as a sole trader remember your claim is limited to only the expenses incurred while you were doing your business. If you have a car or other assets that are used for both personal and business tasks, your claim will be for expenses when you were prying your business.

How do I claim business expenses as a limited company?

You can claim expenses that were used to keep your business running as would a sole trader but claiming allowable expanses will reduce the amount of profit that you have to pay your corporation tax on.

Does information about my sole trader business need to accessible by the public?

One of the plus points for sole traders is that they can keep their information private form public registers.

Does information about my limited company need to accessible by the public?

Yes. Updated company information made available to the public can help you enjoy the benefits limited liability. The information that can be made public must include information about the company, people with significant control, the directors, and members of the company.

Whatever legal structure you want to choose to run your business whether being a sole trader or a limited company keep in mind that all options have their own advantages and disadvantages that you must weigh before diving in.

The below table summarises the fundamental differences between both the structures

Comparatives Sole Trader Limited Company Administration Low Administration.

There are less statutory obligations. High Administration.

There are greater statutory obligations as a Director. Liability You are personally liable for your own finances and possessions may be at risk if things go wrong. You are treated as separate from your limited company; you are protected (provided you meet your statutory responsibilities as a director) from the threat of personal financial losses if things go wrong. Costs and Accounting Setup cost involved is low and the paperwork is very simple as there is no requirement to register your business at Companies House. You only need to inform HMRC within 3 months of trading. Also, accounting is simple and less costly. Setup cost is high as various registrations are required with Companies House and HMRC. Moreover, because of a range of statutory obligations accountancy cost is usually higher. Status Some companies look more favourably towards limited companies and recruiters typically will not engage with Sole Traders. Some companies view a limited company in a more positive manner. Larger companies may refuse to transact with anything other than a limited company. Tax Planning Limited scope for tax planning.There are tax planning opportunities like spousal dividend planning, timing of dividends etc. giving you more flexibility hence tax savings Confidentiality Information is kept private and confidential and is not available to the public as opposed to a limited company. All information like Director’s details, annual accounts and companies trade is publicly accessible.

DNS offers a full range of Sole Trader services at a fixed annual fee with no hidden costs. We can register you with HMRC and assist in filing VAT returns, preparing sole trader accounts and advise on expenses. Please contact us on 0330 088 6686 to find out more.

How We Can Help?

If you are still not sure which is the right option to run your business or if you have already setup and want to understand tax mitigation strategies, then DNS Accountants can help you. For more information on the support we can offer please contact us today.

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Frequently Asked Questions

In the UK, limited companies are the most common type of company. It's a corporate entity which is considered separate to those who own and operate it. Fundamentally, this means that the company can possess assets or enter a contract in its own name, rather than that of the stakeholder.

You might be wondering what does the word 'Limited' in Limited Company mean? This refers to the limited liability afforded to shareholders. It means that shareholders are only responsible for the company's debts, to the value of their shares. Essentially, having limited status means that your company is —in its own right - an entity.

Your Limited Company is established once it has been incorporated. Incorporation also referred to as company formation, involves registering the company with the UK's registrar of companies: Companies House.

What does this mean? Above all, it means that you'll no longer take full responsibility for the company and its tax, national insurance, and other finances. Moreover, the company's finances will be completely independent of your own. In the same way, any profit made from the company is thus owned by the company after it pays its corporation tax. The profits can then be distributed among its members (those people or organisations who have shares in it).

It's important to note that a limited company provides you with added protection if things go awry with your business. Also, it might be easier for you to take our business loans and secure investment.

Because a limited company is a distinct entity from its owners, it may be a little easier for a company to secure business loans and investment. What's more, a limited company might benefit from tax advantages, too.

What happens to a limited company once you retire or resign? The company will continue to exist and operate, ensuring job security for employees.

So, what's the difference between limited and sole trader? It can be challenging to wrap your head around the differences. That being said, the main difference between sole trader vs limited company can be seen in the way that taxation and legal liabilities are applied.

As a sole trader, there's little legal distinction between you and your business. This means that your assets aren't protected. Moreover, all business debts come back to you. A limited company, on the other hand, is a legal entity on its own and therefore the liability shifts to the company. This means that there is less personal monetary risk involved with limited companies.

Setting up as either business structure has its advantages and disadvantages. Fundamentally, it all comes down to your business needs. However, there are some key factors that distinguish these two business structures which we can use to weigh them against each other.

Setting up as a sole trader is relatively simple. All you need to do is file a self-assessment tax return on your annual accounts. It does mean keeping track of all your business transactions and expenses, however, you can always hire an accountant to do that. Once you've filed those taxes you get to keep all of the profits earned from your business and claim the expenses, as opposed to dishing them out to various shareholders or employees. Choosing to go solo as a sole trader means you can maximise your salary and operate with minimal costs. Moreover, you can enjoy greater privacy than incorporated businesses. For more information read our sole trader advantages & disadvantages guide.

On the other hand, setting up as a limited company allows you to enjoy limited liability as there's a legal distinction between you and your business. So you'll only stand to lose that which you invest in the company. This structure is a good idea for small businesses who need greater legal rights to grow with shareholders and employees. For more information read our limited company advantages & disadvantages guide.

It's also a more tax-friendly way to operate, as the company must pay corporation tax on profits rather than income taxes, which are taxed at a higher rate. Moreover, once you've registered your small business company name no one else can use it. Adversely, sole traders aren't offered the same protection.

So, what's better: sole trader or a limited company? There's no definitive answer to this question, as it all depends on your business needs, plans for the future, and what works best for you. If you want to grow and expand your business and reduce liability, then operating as a limited company could well be worth your while and the most efficient way to handle and pay tax and national insurance finances.

If you're confused about whether you should be a sole trader or limited company, there are some things you'll need to consider before making the switch.

The first point to consider is your salary. How much are you earning? If your earnings are relatively low, then it's likely you'll also want to keep your accounting and tax as simple as possible. The sole trader structure is definitely easier to manage, as you'll just have to send a tax return at the end of the year. To do this you might consider hiring an accountant to help organize and track your accounts and expenses. Operating as a limited company usually incurs higher accountant fees than sole traders, but saves you from running around trying to track down all your accounts when the time comes!

As your small business as a sole trader grows, your profits are likely to grow too. Unfortunately, so will the amount of taxation you're required to pay. If your earnings increase, you may need to consider forming a limited company to pay corporation tax instead.

When making this decision it's important to weigh up your overall earnings with the taxation rates you'll need to pay as a limited company director. This will help you to understand whether the costs of running your business as a limited company are going to be worth your while, or if it'll affect the salary you'll take home at the end of the day.

If you're a small business owner and decide to switch from operating as a sole trader to a limited company structure, you'll find there are several advantages. Let's take a closer look at some of the best advantages of making the switch.

1. Limited liability

Changing to a limited company means you, as director, won't be personally liable for any debts your business might incur as the company is a separate entity. This gives you an added level of protection and ensures you won't find yourself caught between a rock and a hard place if things go awry. Your business success isn't always solely dependent on your efforts - there are a number of factors at play - so you must ensure you've got the protection you need just in case things don't go as planned.

With this in mind, as a limited company business owner, it's a good idea to keep separate bank accounts for your finances and your business's. A business bank account could help you to keep track of everything and avoid any taxation surprises.

2. It's more tax-efficient

Sole traders pay taxes on the business profits they make. However, this only happens when you earn more than £11,000 per year. Once your income is more than this as a one-person self-employed sole trader, you could find yourself paying high taxation rates if you earn over £150,000 per annum.

As a general rule of thumb, if you earn up to £30,000 per year you should start thinking about incorporating your business. If you own a growing small business and are wondering whether to switch to a limited company, it's a good idea to consider the amount your business makes.

By changing to a limited company setup, you'll find plenty of benefits when it comes to paying less in personal taxation amounts. You'll be liable for paying corporation instead of income tax on your profits, which is currently set at 18%.

3. Protect your business name

When you incorporate your business you'll need to register its legal name with Companies House. This means it's fully protected, providing insurance that no one else can operate under the same name. This allows you to grow and gain recognition as a business or brand. Moreover, it's a handy advantage if you want to secure a website name, create business cards, or have a logo designed.

4. Reach new levels of professionalism

What do you think of when you see a business name with "Ltd" at the end? That it must be professional, trustworthy, and reliable - right?

Transitioning to a limited company business structure could boost your business to new levels of professionalism and prestige that'll encourage potential clients and existing customers to take you seriously as a business, and —hopefully - invest in your products or services!

There are a few key disadvantages of being a sole trader. These include:

  • Sole traders have unlimited liability. If you run your business this way, the business owner is fully responsible for any debt incurred.
  • Raising finances can be more difficult as banks, insurance companies, and other investors prefer limited companies are they offer more security.
  • Taxation rates for sole traders aren't usually as kind as those for limited companies. Once you reach a certain amount of earnings, you'll have to pay more in taxation. As a company director, it might not be the best option if your business is growing.

If you are thinking of running a limited company keep in mind that it has its own drawbacks which include restrictions when coming up with a company name and having to pay Corporation tax from your taxable income.

Greater complexity

A limited company brings to the table extra paperwork with accounting and administration issues that are time consuming and complex as compared to the less administrative work done by sole traders.

More costs

Professional accounting required to keep books in order is time consuming and costly if there is a need to use an accountant.

Lack of Privacy

Apart from making available company documents on public record, related company owner information is also available for public scrutiny.

Lack of total control

Limited companies directors share equal power and control for decision making and finances.

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