Choosing the right structure for your business is crucial as it impacts your legal obligations, tax liabilities, and overall flexibility. Here’s an overview of the differences between a sole trader business and a limited company.

Sole Trader Business

The Structure of a Sole Trader Business

  • The business is owned and operated by one person. You can have staff and subcontractors but ultimately all the strategic decisions are with you. If there are two (or more) people wanting to start a non-incorporated business as joint owners, that would be a partnership.
    *For simplicity, partnerships are not covered in this article but sit somewhere in between a sole trader and limited company structure.
  • Typically the company is simple to set up and manage, with complete control retained by the owner.
  • A sole trader can be seen as less formal and tends to be associated with small operations. This can make it harder to gain access to finance and opportunities for growth.

Legally speaking

  • Sole traders have unlimited liability, meaning the owner is personally responsible for all debts and liabilities of the business. If your business has a risk of being sued for actions or decisions (e.g. say you write safety reports) then a sole trader structure could put your home and other personal assets at risk
  • There are fewer compliance formalities and reporting requirements compared to a limited company, and registration is easy and inexpensive to set up. Typically you are only required to register for Self Assessment with HMRC.
  • Banking & Withdrawing from the business is very simple. You can use a bank account in your own name, though check with the your bank that the account allows you to use it for business. You can withdraw whenever you want by transferring or spending money. These transactions are called ‘Drawings’ and are not tax deductible, so will count towards your business profit.

Tax for Sole Traders

  • Business Profits are subject to personal income tax which starts at 20%. You have a tax-free personal allowance of £12,570. Remember your Drawings are counted as business profits and only legitimate business expenditure reduces the profit.
  • Sole traders may need to pay Class 2 and Class 4 National Insurance contributions. Class 2 is £3.45 per week and is currently voluntary, though if your business profits are under £ 6725 you will need to pay to get a qualifying year for your pension. If your profits are above this, your Class 2 is deemed as paid. Class 4 is paid on profits over £12570 at a rate of 6%, dropping to 2% on profits above £ 50,270.
  • You must file an annual self-assessment tax return if your trading income (not profit) is £1,000 or more.

Limited Company

The Structure of a Limited Company

  • A limited company is owned by the shareholders and run by directors. These can be one and the same, it’s common to have one Director who is the sole shareholder.
  • Directors manage the day-to-day operations, but major decisions are made by shareholders. Therefore control of business decisions could be complicated if there are a lot of people involved.
  • Limited companies are more complex to set up and manage. You will need to keep formal documents detailing the shareholders and Directors and keep this information up to date with Companies House, who will also require identity verification of these people.
  • A Limited Company is sometimes perceived as more professional, and can facilitate easier access to finance and growth opportunities.

Legally speaking

  • A limited companies is so called because there is Limited personal liability for debts if things go wrong. Shareholders are only liable up to the amount they invested. The company is a separate legal entity, even if there is only one shareholder and Director.
  • For compliance, you will need to report your accounts and company tax return annually to Companies House and HMRC in a specified format, as well as completing your self-assessment tax return as a director. This may mean you need buy specific software or to procure the services of an accountant or bookkeeper to complete this for you. The Director(s) is responsible to make sure the documents are filed in timely fashion, otherwise the company can be struck off.
  • To register a limited company you are required to incorporate with a Companies House in the UK. There is a fee, starting from £50, for registration and ongoing annual fees of £34 per year to file your Confirmation Statement if done online. You will need to choose a company name which isn’t already taken by a similar company. You may be refused a name if it’s too similar to an existing incorporated business.
  • Banking and withdrawing money is much more complex than in a sole trader setup. You must have a bank account in the company name. All monies belong to the company as you and the company are separate legal entities. To take any money out, you are paid salaries or wages as an employee (through an official payroll reported to HMRC). Wages are a business expense, so tax deductible. As a Director or shareholder, you can withdraw dividend from profits after it has been agreed and documented by the board. Even if “the board” is just you, you need to document the meeting and issue Dividend vouchers. If you draw more dividend than you should be allowed, you will pay tax on this as an ‘overdrawn Director’s loan’ at 33.75%.

Tax for Limited Companies

  • There is no personal allowance for the limited company (personal allowance belongs to you as an individual). All company profits are subject to corporation tax (currently between 19% and 25% depending on the level of your profits). Corporation tax is calculated from the annual filing of the Corporation tax return to HMRC.
  • National Insurance: As a limited company, you pay Class 1 Employer National Insurance contributions from the company at 13.8% on salary is above £9,096. This is a tax deductible expense. The Director is an employee and all employees have Class 1 Employee National Insurance contributions deducted from their wages when they exceed £12,570.
  • Dividends work much like Drawings, in that it’s a way to take money out of the company outside of payroll. However Dividends must be declared and then paid from the company profits. The tax on dividends starts at 8.75% so much lower than 20% income tax. The first £500 of Dividend is taxed at 0% under Dividend Allowance.

Key Differences

      Sole Trader      Limited Company
Unlimited liability
Personal assets are at risk     
Limited liability
Personal assets are protected     
Income taxed as personal income     
Profits taxed at corporate rates
dividends taxed separately     
Less paperwork
simpler compliance     
More regulatory requirements
higher administrative burden     

Choosing Between Sole Trader and Limited Company

These are the main points to consider when choosing your business structure.

  1. **Risk and Liability**: If your business involves significant financial risk, a limited company can protect personal assets.
  2. **Administrative Capacity**: A limited company requires more administrative effort and costs.
  3. **Growth Plans**: A limited company might be better suited for scaling and attracting investment.
  4. **Professional Image**: A limited company can enhance credibility with clients and suppliers.
* A note on tax efficiency. Depending on profit levels, a limited company may offer tax advantages. However these savings are often so minimal that they are wiped out by administrative costs. Tax shouldn’t ever be the sole driver when making these decisions.

Many people start as a sole trader to see how the business pans out and decide to change to a limited company when they achieve more success. There are a few additional things to think about if changing from a sole trader business to an incorporated one:

  • you will have to change your business bank account so as to have account(s) in the company name (you can’t use a personal one).
  • you will need to ‘sell’ the business to the limited company, meaning a rudimentary valuation and a calculation of goodwill. Depending on the value, it may need to be agreed by HMRC and pay capital gains tax on it.
  • if you are VAT registered as a sole trader, you will need to close down that VAT account and open a new one under the limited company name.
  • if you are using accounting software, you will also need to close this account and open a new one starting afresh as the limited company starts. You may also need to retain access to the sole trader account for some time as you switch over.

In Conclusion

With so many complicated factors to consider, it’s always advisable to consult with a legal or financial professional to determine the best structure for your specific circumstances and jurisdiction. However, in brief

  • Sole Trader structure is best for small, low-risk businesses with straightforward finances and operations.
  • Limited Company structure is suitable for businesses seeking growth, investment, and limited liability protection.

If you need any help to discuss this, get in touch. If I can’t help you, I can point you in the direction of someone who can.

* The figures and rates used are correct at the time of publishing and may be subject to change

For Reference:
GOV.UK | Income Tax rates and Personal Allowances
GOV.UK | Corporation Tax Rates
GOV.UK | National Insurance Rates and Thresholds
GOV.UK | Companies House Fees

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