[10.02.25]
This summary is of necessity a simplification and there are different types of both incorporated and unincorporated business structures but the two most commonly used are the Limited Company & the Sole Trader
There are a number of differences between operating your business as a sole trader or through a limited company. Here we discuss the differences and the pros and cons of both.
Liability
The most important feature of a limited company is that it is a separate legal entity from its shareholders and directors. This means that its liabilities are not the shareholders’ or directors’ liabilities and similarly that the company’s assets are not the shareholders’ or directors’ assets.
Conversely the law does not recognise any distinction between an individual’s private and business affairs when that individual is simply trading on their own account (ie a sole trader). Consequently, the individual’s ‘private’ assets – for example, their home – are available in law to pay business debts in the same way as assets of the business are.
Using a company correctly means that an individual’s risk is limited to the amount invested in the company, giving the owners valuable peace of mind; whilst the sole trader’s liability is unlimited.
Research undertaken by HMRC in 2014 found that limited liability was the most popular reason for incorporation – with 24% of respondents citing that as their reason, with the next popular reason being tax and national insurance savings at 19% of respondents.
The benefits of limited liability are reduced in some circumstances; for example, where bankers and others lending money to the company require other security or personal guarantees from the shareholders. However, limited liability may provide some protection against trade creditors in the event of business failure.
Tax Position
For many traders, the attraction in using a limited company will be perceived tax savings. Whilst the rules for calculating the trading profits of an individual and the trading profits of a company are similar, there are some important differences.
A company’s income is subject to two levels of tax:
- firstly, the profits are subject to corporation tax as they are earned; and
- secondly, the after-corporation tax profits are subject to income tax and possibly NICs when paid to the owner.
With regard to the first layer of tax, the company has a significant advantage over the unincorporated business: whereas the company pays corporation tax on its profits at the rate of 19%, the combined rates of income tax and Class 4 NICs for the unincorporated business can be much higher. This means that using a company can increase the amount of profits available to invest in growing the business.
This advantage is eroded where some or all of the after-tax profits are withdrawn from the company by the owner, when the second layer of tax comes into play. However, a carefully planned and managed remuneration strategy can minimise the income tax/NICs due with the result that a tax saving may be achieved at some profit levels even where all of the after-corporation tax profits are withdrawn from the business.
Administration
An individual starting in business in the UK as a sole trader does not generally need permission to do so, unless entry to the sector concerned is regulated by Government (e.g. the medical profession) or by professional institutes.
A limited company has to register with Companies House and file annual accounts and other reports which are publicly available. Also should you decide to close-down the business, it is more complex and there is more admin for a limited company.
Responsibilities
Directors of a limited company have legal responsibilities to ensure the company is run lawfully. Failure to meet these obligations can result in penalties or disqualification as a director. These responsibilities must be taken seriously by directors.
Raising Capital
It can be easier for a limited company to raise capital. Some forms of finance require a business to issue shares, which would require restructuring to a limited company.
Others’ Perceptions
Some customers and suppliers see sole traders as less established or less stable, compared to a limited company, which could impact the ability to attract business or deliver the services to your current customers.
Business Strategy
If you have plans for steady growth and expansion, which may require more employees, or need to regularly engage expertise or additional resources, or secure investment, you should consider incorporating the business to a limited company.
Continuity
As a limited company has a separate legal entity from its owners, it can continue to exist even if the original owners leave the business. This means you can create a legacy for the business.
Myth-busting:
Myth 1: Being a Sole Trader Is Always Cheaper
The Reality: It’s true that sole traders have fewer setup costs and less paperwork. However, this doesn’t automatically make it the most cost-effective option. Sole traders are taxed on all profits at current income tax rates. In contrast, limited companies pay corporation tax and offer tax planning opportunities, such as taking dividends instead of salary.
How Castletons Can Help: We will help you to understand the long-term financial implications of both structures. Our goal is to ensure you don’t overpay on taxes while staying compliant with HMRC regulations.
Myth 2: Limited Companies Are Too Complicated to Run
The Reality: While a limited company does require more paperwork, such as annual accounts and confirmation statements, the process isn’t as daunting as many believe. With the right systems and support, managing a limited company can be straightforward. Even better – leave it to an expert to manage for you.
How Castletons Can Help: We specialise in helping small business owners set up and run limited companies. From filing accounts to managing payroll and VAT, we take care of the admin, so you can focus on your business.
Myth 3: Sole Traders Don’t Need to Worry About Compliance
The Reality: As a sole trader, you still have responsibilities, including registering with HMRC, filing a Self-Assessment tax return and paying income tax and National Insurance. If you don’t comply with HMRC rules, you risk penalties and fines.
How Castletons Can Help: We ensure you stay on top of your obligations, whether you’re a sole trader or a limited company. Our expert team keeps up with the latest HMRC legislation and acts on your behalf so you don’t have to.
Myth 4: Limited Companies Always Save You Money
The Reality: While a limited company can be more tax-efficient in many scenarios, it’s not a one-size-fits-all solution. Factors like your income level, business type and future growth plans play a significant role in determining whether incorporation is the best choice.
How Castletons Can Help: We will understand your business and personal goals before recommending a structure. Our advice is unbiased and tailored to your specific situation, ensuring you make the best choice for your future.
Myth 5: Switching Between Sole Trader and Limited Company Is Impossible
The Reality: It’s possible to transition from sole trader to limited company (or vice versa), but the process requires careful planning to avoid tax complications and ensure a smooth handover.
How Castletons Can Help: If your circumstances change, we’ll guide you through the transition, handling everything from HMRC notifications to setting up a new company structure
Myth 6: A Sole Trader Does Not Have to Register for VAT
The Reality: A sole trader can be VAT registered – and must be VAT registered if the income is higher than the VAT threshold.
How Castletons Can Help: We can advise you when you should look to be VAT registered and can register you for VAT.
Myth 7: A Sole Trader Can Not Employ Staff
The Reality: A sole trader can employ staff, but you can not be an employee of the business yourself.
How Castletons Can Help: To employ staff you must register with HMRC as an employer – we can do this for you and we can run and manage your payroll, ensuring you pay your staff correctly and you are compliant with HMRC’s rules.
Five key questions to ask when considering your business structure:
- How important to you is the ability to limit your exposure in the event of a claim against the business? – If it is important, a limited company is the right approach for you.
- Are you concerned that some company information is publicly available? – Privacy and/or data security concerns can rule out using a company for some people.
- Do you expect to make a loss in the early years of trading? – Making a loss can be quite common in the early years due to the greater need to invest in the business, and as it will take time to grow the customer base. Relief for the loss may be obtained at a higher rate of tax, and more quickly, by a sole trader.
- Once established, how much do you expect to make each year in profits? – Although using a company can give rise to a tax advantage, this may not be enough to compensate for the additional accountancy fees.
- Have you given any thought to how and when you will write up your business records? – Using a company requires a degree of financial discipline. For example, up-to-date accounts are required to support the payment of dividends.
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