There are many factors to consider before setting up a business, one being – do you trade as a sole trader or limited company. The most important considerations are: income, future business plans, tax implications, the industry you operate in, the types of clients you wish to attract, and the level of record-keeping and accounting you are prepared to do.
There are so many benefits to running a business as a limited company, but it won’t appeal to everyone. Operating as a sole trader is much simpler because there are far fewer filing and accounting requirements. However, if tax savings, financial protection and corporate prestige are at the top of your list, you should definitely consider company formation.
Before making any decisions, we recommend speaking to an accountant or professional advisor for help.
- What is the difference between a sole trader and a limited company?
- Do I have to register with Companies House to set up as a sole trader?
- Tax efficiency – Income Tax vs corporation tax
- How to change your business from sole trader to limited company
- Do sole traders and companies require business insurance
What is the difference between a sole trader and a limited company?
A sole trader is a self-employed person who registers a business with HMRC. As a sole trader, you can work on your own or employ other people, but you will be wholly and personally responsible for the business and its liabilities. There is no legal distinction between you and your business. You must register for Self Assessment, pay Income Tax and National Insurance Contributions on all taxable income, and file Self Assessment tax returns each year.
Sole trader advantages
- You can register online in just a few minutes.
- No need to incorporate at Companies House.
- No registration fee.
- Usually inexpensive to get started.
- Minimal bookkeeping, accounting and filing requirements.
- Accounting costs are usually lower. You may even be able to do your own accounts and tax returns.
- Full ownership and control of the business.
- Decisions and changes are quick and easy to make.
- All profit after tax belongs to the sole trader.
- No personal or business details are disclosed on public record.
Sole trader disadvantages
- Sole traders have unlimited liability for all debts and claims because there is no legal distinction between personal finances and business finances.
- The individual is wholly responsible for making all decisions.
- Can be more challenging to raise capital.
- All taxable income of the sole trader is liable for Income Tax and NI.
- Larger companies and lenders prefer dealing with incorporated business structures rather than sole traders.
- Often viewed as smaller and less established than incorporated structures. Limited companies are viewed as more professional and credible.
- Not as tax-efficient as a limited company.
- Not always possible to meet the criteria for statutory sick pay and maternity pay
A limited company is a type of business structure that is incorporated (registered) at Companies House. It is a distinct legal entity that is completely separate from its owners and responsible for its own finances and debts. The owners benefit from reduced financial responsibility for business debts. This is known as limited liability.
Most companies are limited by shares and owned by shareholders. Some are limited by guarantee and owned by guarantors. Limited by guarantee is the preferred choice of non-profit organisations whose owners do not take a share of trading profits. Companies are managed by one or more directors, who may or may not also be the owner(s).
Companies must pay corporation tax on all taxable profits, submit tax returns each year and comply with a number of statutory filing and reporting requirements under the Companies Act 2006. Despite the additional administration, it is a very tax efficient structure for many people.
Advantages of a limited company
- Distinct legal entity that is separate from its owners.
- Provides limited liability. This means that the personal finances and assets of shareholders/guarantors are protected beyond what they agree to invest or guarantee to the business.
- Professional credibility and improved status.
- Often viewed as larger and established corporations, even if they are owned and managed by just one person.
- Appeal to a broader range of potential clients.
- Often easier to raise capital from lenders and investors.
- Can be easier to grow a business when it’s set up as a company.
- Enjoy perpetual existence, which means they remain in existence beyond the involvement of the original owners.
- Pay corporation tax on all taxable income.
- Often more tax-efficient.
- Directors can pay themselves a mixture of a salary and dividends, which is more tax-efficient.
- Can sell shares in exchange for capital investment.
Disadvantages of a limited company
- Must be incorporated at Companies House. However, this is not very time-consuming.
- Must register with HMRC for corporation tax.
- Sometimes costs more to set up.
- There are certain restrictions when choosing a company name.
- Not possible to register one if you are an undischarged bankrupt or disqualified director.
- Must have a registered office address in the same part of the UK where the company is incorporated.
- Directors, subscribers, secretaries and People with Significant Control (PSCs) must provide a service address.
- Information is placed on public record. This includes the registered office address, service addresses, directors’ details, shareholders’ details, PSC details filing history and financial activity.
- Accounting and filing requirements are more complicated and time-consuming than sole trader administration.
- May need to hire an accountant.
- You cannot simply remove money from a company as and when you please. You must have enough profit left after the deduction of tax and other expenses before doing so, and you must follow strict procedures to remove money and pay yourself.
Do I have to register with Companies House to set up as a sole trader?
Sole traders do not have to be registered at Companies House. You only need to do this if you are setting up a limited company or Limited Liability Partnership (LLP). To operate as a sole trader you must register with HMRC for Self Assessment. This is a really straightforward procedure that can be carried out online in a matter of minutes. To do so, you will need to provide the following details:
- National Insurance number.
- Full name and home address.
- Personal contact details.
- Name and address of your business. You can use your own name and home address, unless your business has a unique name and separate trading address.
- Date you started in business.
- Main activities of your business.
HMRC will send you a letter within a few days of registering online. This will contain your personal Unique Taxpayer Reference (UTR) and details of your responsibilities and obligations as a sole trader.
Tax efficiency – Income Tax vs corporation tax
Sole traders pay Income Tax on all profits above their £12,500 Personal Allowance. Limited companies pay corporation tax on profits. Depending on the amount of profit you make, a company may be more tax efficient because corporation tax is currently set at 20%, whereas Income Tax rates vary:
- 20% (£12,500 – £50,000 annual income)
- 40% (£50,001 – £150,000)
- 45% (income exceeding £150,000)
By running your business as a company, you can minimise your Income Tax and NIC by taking a director’s salary up to your tax-free Personal Allowance of £12,500 or the NIC threshold of £8,632 (2019-20 tax year). The rest of your income can be taken as dividends.
A salary is a tax-deductible expense, so you will not have to pay corporation tax on it. Dividends are paid from company profits after corporation tax has been deducted, so no Income Tax or NIC will be deducted from this part of your income. However, you will start paying dividend tax on dividend income above £2,000 per year.
If you keep your total annual income below £50,000 (£12,500 tax-free Personal Allowance + £37,500 basic rate threshold), you will pay considerably less personal tax through a company than as a sole trader.
How to change your business from sole trader to limited company
You can change from a sole trader to a limited company in just 3 working hours by sending an online application to Companies House. Simply check the availability of your company name using 1st Formations online name-checker, choose a company formation package and enter the following information on the application form:
- Company name.
- Registered office address.
- Director’s details (minimum of 1).
- Shareholders’ or guarantors’ details (minimum of 1).
- PSC information.
- Service address for each director, company secretary, subscriber and PSC.
- SIC code(s)
- Memorandum and articles of association.
- Details of issued shares (if applicable).
Applications are submitted electronically to Companies House. Once approved, your new company will be ready to trade on the very same day and you will receive digital copies of your incorporation documents via email.
Do sole traders and companies require business insurance?
Many sole traders and limited companies are not legally required to take out any kind of insurance unless they employ people, in which case Employers’ Liability Insurance is compulsory. However, we strongly urge all businesses to protect themselves from property damage and personal injury claims by taking out public liability insurance.