Difference Between Sole Trader and a Limited Company

The first decision when deciding to work for your self is whether to be a sole trader or limited company. There are advantages and disadvantages to both. This article looks into the difference between the two to help guide your decision process.

A commonly asked question in the world of business, is whether the self-employed should trade as a company or as an individual. It can certainly create a few headaches; especially for non-UK residents who may not be fully aware of UK tax and compliance. Whichever decision is made it has implications on tax, legal and financial consequences. So let’s start with a quick explanation of both.

Sole Trader Tax Return

A common theme cited is that, as a sole-trader it’s the easiest type of business to run on a day to day basis and also better suited for small business entities. However, this is not strictly true as the bookkeeping can be quite complicated. As a sole-trader you are classed as self-employed, but you will not pay yourself a salary. Instead you can draw money from the business’ earnings and you will pay tax on the total earnings the business makes as Income Tax and National Insurance. So you will need to prepare and submit a yearly self-assessment tax return to HMRC to calculate the taxes. It’s very important that you leave enough in the account to pay for your taxes when they are calculated.

The risk as a sole-trader is that there is full personal liability if the business were hit any trouble. All debts will be attached to the individual and not the business. This is just about rule number one in the sole trader manual!

Limited Company Means Limited Liability

A Limited company is a separate legal entity. This means the owners or shareholders of the Limited company are not personally responsible for its debts.

Setting up an entity in this way involves a process called incorporation. The incorporation has to be submitted to, and approved by Companies House. We offer an online incorporation process which involves you filling in a four-step form. We will review your application for errors before filing with Companies House. This helps minimise rejections and delays.

Shareholders – your company is fully controlled by those who own shares. You can designate yourself the sole shareholder or add others such as family members if you wish to share the company with them. This can have financial advantages as you can pay them dividends. 

A differing factor from trading between the two is that as a shareholder of a limited company. You have the potential to pay less tax as they can pay themselves small salaries and high dividends. The current basic rate of tax on dividends is 7.5%

Key Limited Company Advantages

Below we like to categorize some of the main differences, as we believe all entrepreneurs should be aware of:

1.  Professional image – This may prove to be beneficial when conducting business with larger firms, some may dismiss business with sole traders due only to the fact of their set up.

2.  Securing funding/investments – Theoretically it can be easier to secure investment due to the aforementioned features of a limited company. The mass perception is that registering as a Limited company provides more credibility in this situation.

3.  Naming – As a limited company, you’re registered name is protected by law, but no such protection exists for sole traders.

4. Cost of incorporation – A common misconception is that it’s expensive and time consuming to form a limited company over a sole trader. In reality the process is so simple, affordable and quick that it’s not an issue to complete. We should know!

The decision is a key one as this will form the basis of your business operation. Our team at Set up a Company have been helping new businesses get off to the right start for over 40 years! We can help you through the process of setting up your limited company. We also provide ongoing company support services to help keep you compliant with your company requirements.

Categorised in: Entrepreneurship, Uncategorised

This post was written by Chris Beck