Limited Company or Sole Trader: Which is Right for You?
I often get asked by my clients, ‘Should I be a limited company or a sole trader? Which would be better for my company?
In this article, I will outline some of the pros and cons of each status to help you make that decision.
1. Introduction
A limited company is a separate legal entity that is set up at Companies House. A limited company will have directors and shareholders who are responsible for running the business and maintaining the accounting records.
A sole trader is someone who trades as themself, paying income tax on the profits.
2. Limited company
Pros
The main reason for wanting to incorporate is to limit your liability. However, although this is technically a ‘Pro’ the scope of this isn’t very high – see my point in Cons!
The overall tax paid can be lower, particularly if this is a second income stream and the profits are kept within the company rather than drawn down. Corporation tax rates are 19% and 25%, which are lower than income tax rates of 20%, 40%, and 45%.
If the ultimate plan is to either sell or pass on the company, then this vehicle is useful as it means that the shares can be sold or transferred. This can be more straightforward than having to do the split of assets and goodwill that selling an unincorporated business involves.
Cons
As indicated above, often the liability isn’t that ‘limited’. For example, if you were buying a large asset and taking out finance for this, then it is likely that the finance company would require a personal guarantee from the directors. Likewise, if your company goes insolvent, there are measures to ensure that you can’t just set up another company and carry on trading, too.
This lack of liability was evidenced quite clearly by the Bounce Back Loans issued through the Pandemic, where people realised they couldn’t afford to repay their loans and tried to strike off the company. This was then blocked by banks who insisted that either the company remained until the loan was repaid, or the loan be taken on personally instead.
There are a lot more layers of compliance. You will need to:
- operate a payroll with the associated pension compliance as well as PAYE obligations
- satisfy Companies House that you are a bona fide business in the UK
- do a corporation tax return
- you will still need to do a self-assessment return
This generally means that your accountancy fees are a lot higher, too!
Depending on how you want to take out the money generated within the company, the overall tax paid can be higher. In other words, as dividends are drawn from after-tax profits, they are then taxed personally.
3. Sole trader
Pros
It is generally a lot simpler to operate as a sole trader. Consequently, your accountancy fees are also likely to be considerably lower than those of a limited company.
As the tax is paid on your profits, any surplus money generated is yours to spend how you like. You won’t get taxed again by drawing the money from the business as you do with dividends.
Cons
There isn’t any flexibility with your tax as you get taxed on the profits made, not what you draw down.
There isn’t any limited liability – although, as I’ve outlined above, this isn’t actually what it appears to be anyway!
In the next couple of years, Making Tax Digital will be introduced for individuals, which means that you will have to use cloud software to run your business and make quarterly returns to HMRC. There is an upside to this, though, as your accounts will be more up-to-date and, therefore, more usable to you as the business owner!
Conclusion
There are many factors to consider when deciding how to trade. It is always best to discuss these with your accountant before you make any final decision. Click here to get in touch with me.