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  • Writer's pictureDonatas Mendelis

Sole Trader vs Limited Company: What Is Better for Your UK Business?

Updated: Jan 5






As an entrepreneur starting a new venture in the United Kingdom, it's crucial to carefully consider the appropriate UK business structure to ensure the success and financial well-being of your enterprise.


One common dilemma faced by entrepreneurs is the choice between operating as a sole trader or forming a limited company. Both structures offer unique benefits and challenges, with varying implications for taxation, liability, and management.


This article aims to provide a comprehensive comparison of sole trader vs limited company structures to help you make a well-informed decision and choose the best path for your growing UK business.


Understanding   the   Basics:    Definitions   and   Key Differences


Before deciding whether to operate as a sole trader or a limited company in the UK, it is crucial to understand the core characteristics and distinctions between these business structures. This section delves into the definitions, processes, and key differences of both setups.


What Is a Sole Trader?

 

A sole trader is an individual who sets up and runs a business on their own. As a self-employed person, the sole trader assumes full responsibility for the business's debts and liabilities. The process to become a sole trader in the UK is relatively simple and involves registering with HRMC for self-assessment and acquiring a Unique Taxpayer Reference (UTR).


Some advantages of being a sole trader include the uncomplicated setup process, complete control over business decisions, and fewer administrative demands. However, the sole trader also faces unlimited liability, meaning their personal assets could be at risk if the business encounters financial difficulties.


What Is a Limited Company?

 

A limited company is a separate legal entity, distinct from its owners. It is managed by a company director and owned by shareholders. To set up a limited company in the UK, one must register with Companies House, providing essential information and documentation.


One of the main benefits of a limited company is the concept of limited liability, protecting shareholders' personal assets from company debts or legal disputes. Nevertheless, running a limited company entails more responsibilities, such as maintaining accounts and filing necessary documents with government agencies.


Comparing Sole Trader and Limited Company Structures

 

There are notable differences between sole traders and limited companies. On one hand, sole traders face unlimited liability, whereas limited companies offer personal asset protection through limited liability. Moreover, sole traders and limited companies have separate tax requirements, with sole traders paying income tax on profits and limited companies paying corporation tax.


When it comes to ongoing administrative tasks, sole trader structures have comparatively fewer requirements compared to limited companies. However, limited companies allow for better scalability as they grow and expand their operations.

In conclusion, both sole trader and limited company structures have their respective advantages and disadvantages. The choice ultimately depends on individual circumstances, financial objectives, and plans for future business growth.

Aspect

Sole Trader

Limited Company

Liability

Unlimited liability

Limited liability

Taxation

Income tax on profits

Corporation tax

Administration

Less onerous

More demanding

Scalability

Lower

Higher

The Advantages and Disadvantages of Operating as a Sole Trader



Operating a business as a sole trader can provide numerous benefits and drawbacks, depending on the individual's circumstances and the nature of the enterprise. This section will explore the advantages and disadvantages of this business structure, focusing on aspects such as financial management, unlimited liability, tax implications, and fundraising challenges.


Advantages of being a sole trader


One of the primary benefits of operating as a sole trader is the simplicity of managing finances. Unlike limited companies, sole proprietors can keep their financial affairs straightforward and uncomplicated, as there is no legal distinction between the individual and the business. As such, they can use their personal bank accounts for business-related expenses and make decisions based on their preferences.


Another advantage is the ease of setting up and managing the business. Sole traders do not have to deal with the extensive paperwork and administrative tasks required to establish a limited company. Furthermore, they can maintain one self-assessment tax return for their income.


Sole traders also benefit from a relatively straightforward tax system. As individuals, they are not subject to corporation tax and can benefit from simplified annual accounting. This can result in less hassle and stress when managing tax obligations.


Disadvantages of being a sole trader


One of the major disadvantages of operating as a sole trader is unlimited liability. Since sole proprietors and their businesses are legally regarded as one entity, they bear the entire burden of any financial losses or legal claims. This means their personal assets, such as their house or car, could be seized to repay outstanding debts.


The lack of legal separation between the individual and the business makes it difficult to raise funds and attract investors. Investors may perceive sole traders as less stable and more risky, resulting in limited access to capital for business growth and expansion.


Additionally, sole traders are not eligible for certain tax benefits and reliefs available to limited companies, such as the lower corporation tax rate and dividend payments. As a result, they might pay higher taxes on their income as the business grows, reducing the net earnings retained in the long run.

Advantages

Disadvantages

Simplicity of managing finances

Unlimited liability

Ease of setup and management

Potential challenges in raising capital

Straightforward tax system

Limited access to tax benefits and reliefs

In conclusion, operating as a sole trader can bring both advantages and disadvantages. Each entrepreneur must evaluate their unique circumstances, business goals, and individual risk tolerance to determine whether the sole trader structure is the most suitable choice. It is advisable to consult with a professional accountant such as Accountant Bookkeeping for personalized guidance and recommendations on selecting the best business structure for one's needs.


Benefits and Challenges of Running a Limited Company


While many entrepreneurs find the idea of operating as a limited company appealing, it's essential to understand both the advantages and potential challenges one can face.


Advantages of Incorporating a Limited Company


One of the most significant limited company pros is the protection of limited liability. This means that the owners, or shareholders, are only responsible for the company's debts up to the value of their shares. Consequently, their personal assets are protected from any claims against the company.


Another key benefit is the potential for tax savings. Unlike sole traders who pay income tax on their profits, limited company owners pay corporation tax, which generally has a lower rate.

Moreover, business owners can also receive various tax reliefs, significantly enhancing their tax efficiency.


Being a limited company also promotes a more professional image to potential clients and suppliers. This can help attract new customers and facilitate smoother business relationships based on trust and credibility. Additionally, the company name is protected from use by other businesses in the UK.


Furthermore, limited companies can raise capital by issuing shares. This allows them to bring in new investment more easily than sole traders.


Advantages

Description

Protection of Limited Liability

Owners/shareholders are only responsible for

the company's debts up to the value of their

shares, protecting their personal assets from

any claims against the company.

Potential for Tax Savings

Limited company owners pay corporation tax,

which is generally at a lower rate than income

tax for sole traders. Business owners can

also receive various tax reliefs, enhancing

their tax efficiency.

Professional Image

Operating as a limited company promotes a

more professional image to potential clients

and suppliers, helping to attract new

customers and establish trust and credibility.

The company name is also protected from

use by other businesses in the UK.

Ability to Raise Capital by Issuing Shares

Limited companies can raise capital more

easily than sole traders by issuing shares,

allowing them to bring in new investment.


Disadvantages that Limited Companies Face 


Operating as a limited company also comes with some challenges to consider. For instance, limited companies are subject to certain regulatory requirements by HMRC. This includes the need to pay corporation tax, file annual accounts, and maintain additional records.


Another downside is the increased administrative burden. Limited companies have to submit their annual accounts and annual confirmation statements to Companies House. These documents are publicly available, which might be a concern for business owners concerned about the disclosure of their financial information.

Lastly, limited company owners may need to register for VAT if their turnover exceeds the threshold set by HMRC.


Challenges

Description

Regulatory requirements 

Pay corporation tax, file annual accounts, maintain additional records

Administrative burden 

Prepare and submit annual accounts and statements to Companies House

Public disclosure 

Financial information is accessible to the public

VAT registration 

May be required if turnover exceeds the set threshold

Tax Implications: Making the Most of Your Money


In this section, we will explore the various tax implications for both sole traders and limited companies. We will discuss different tax rates, the role of national insurance contributions, and tax efficiency strategies. Additionally, we will cover the tax obligations for each business structure, including capital gains tax and corporation tax.


  1. Income Tax and National Insurance

As a sole trader, your profit is taxed as income. The personal allowance is £12,570, meaning no income tax is paid on this amount. The basic tax rate is 20% for income between £12,571 and £50,270, the higher rate is 40% for income between £50,271 and £125,140, and income over £125,140 is taxed at a rate of 45%. You can estimate your tax obligation on the HMRC website.

Sole traders also pay National Insurance contributions. For the 2023/24 tax year, Class 2 National Insurance is £3.45 per week for profits over £12,570. Class 4 National Insurance applies at a rate of 9% on profits between £12,570 and £50,270, and profits over £50,270 are subject to an additional rate of 2%.


For limited companies, the corporation tax rates for 2023/24 are 19% for profits below £50,000, and 25% for profits between £50,000 and £250,000 (eligible for Marginal Relief) and above £250,000 (not eligible for Marginal Relief). Directors of limited companies pay themselves a salary, which is subject to income tax and national insurance deductions


2. Tax Efficiency


When an individual's earnings as a sole trader begin to increase significantly, the tax efficiency of this structure often diminishes due to the applicable income tax rates of 20% for basic rate taxpayers and 40% for those in the higher rate bracket. As such, reaching the threshold of the higher income tax rate frequently signals a good time to consider moving towards a limited company structure.


Shifting to a limited company offers notable tax advantages, particularly due to the increased flexibility in remuneration methods available to a director. This flexibility includes the ability to extract earnings through a combination of salary, dividends, and pension contributions. Generally, the tax liability for a director of a limited company is lower compared to that of a sole trader. Furthermore, for profits under £50,000, the tax rate stands at 19%. This rate increases to 25% for profits exceeding £250,000, with a provision for marginal relief applicable within these profit ranges.


The decision to transition from a sole trader to a limited company structure for tax purposes depends on various factors. This shift typically becomes advantageous when the tax benefits outweigh the simplicity of being a sole trader. In the scenarios discussed below, using the 2023/24 tax rates, we've assumed that the director of a limited company draws a salary up to the personal allowance limit of £12,570, with the remainder of their income taken as dividends. For the 2023/24 tax year, the first £1,000 of dividend income is tax-free, offering an additional incentive for this approach.



Sole Trader Take Home

Director (Ltd Company) Take Home

Benefit to move to Ltd company

Profits – £30K

£24,766

£25,187

£421

Profits – £50K

£38,966

£39,969

£1,003

Profits – £75K

£53,501

£54,733

£1,232


Within a limited company, the Director Shareholder has the flexibility to choose how they receive

remuneration, offering the option to either withdraw earnings or reinvest them back into the

company. This contrasts with the sole trader structure, where taxation is based on the profits

generated, irrespective of whether these profits are withdrawn or reinvested in the business.

The comparison table clearly illustrates that as profits rise, operating as a limited company

becomes a more tax-efficient option compared to being a sole trader.


3. Capital Gains Tax


For the 2023/24 tax year in the UK, both sole traders and limited companies are subject to

capital gains tax (CGT) when selling business assets, such as property or equipment, at a profit.

The CGT rates vary depending on the total taxable income and the type of asset being sold. For

individuals, the CGT rates are 10% for total taxable gains and income below £37,700, with any

excess gains taxed at 20%.


For residential property and carried interest, the rates are 18% and 28% respectively. The lower

rate applies if the overall annual income is below £50,270, while the higher rate applies if it is

above this threshold. Additionally, gains qualifying for Business Asset Disposal Relief are taxed

at a rate of 10%, subject to a £1 million lifetime allowance. This relief is applicable to both sole

traders and limited companies under certain conditions.


4. Tax Requirements


Business

Structure

Primary Tax Requirements

Sole Trader

Submit a self-assessment tax return to HMRC, including income tax

and national insurance contributions.

Limited

Company

Pay corporation tax on profits and file annual accounts with

Companies House. Directors must submit a self-assessment tax

return for their salaries and dividends.

It is crucial to comply with all tax requirements and deadlines to avoid penalties from HM

Revenue and Customs. Consider consulting a professional accountant or tax advisor to help

you navigate the tax system and ensure that your business remains tax compliant while

maximizing tax efficiency.


Conclusion: Making an Informed Choice for Your Business


In summary, the decision to operate as a sole trader or a limited company largely depends on

your individual circumstances, financial objectives, and business plans. Each structure offers

unique benefits and challenges that can influence the long-term success of your business.

Considering factors such as taxation, liability, administration, and growth opportunities are

crucial in making an informed business decision.


As a sole trader, you will benefit from the simplicity of managing finances, a straightforward tax

system, and complete control over your business. However, you will face unlimited liability and

potential challenges in raising capital. On the other hand, limited companies offer limited liability,

potential tax savings, and a more professional image, but come with increased administrative

burden and regulatory requirements.


Evaluating the differences between these business structures will help you determine the best

option for your unique needs. It's essential to analyze and weigh the pros and cons, considering

the impact each choice may have on your business model, objectives, and strategy.


To ensure the best decision for your business, it is advisable to consult with a professional

accountant who can provide personalized guidance based on your specific situation.

Remember, choosing the right structure is a crucial part of your entrepreneurial journey, and

making an informed choice can greatly improve your chances of success.


FAQ


What is the main difference between a sole trader and a limited company?

The primary difference lies in liability and business structure. A sole trader operates as a

self-employed individual, with personal responsibility for any business debts and no legal

separation between personal and business assets. In contrast, a limited company is a separate

legal entity with limited liability for its directors and shareholders, providing protection for

personal assets.

How do tax implications differ for sole traders and limited companies?

What are the advantages of operating as a sole trader?

What benefits can a limited company provide?

How do I decide whether to operate as a sole trader or a limited company?

Can I switch from being a sole trader to running a limited company?


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