One of the first things you need to consider before starting up is whether to register as a sole trader (or partnership), or set up a limited company. There are significant differences between the two types of business structure.
Sole Trader vs. Limited Company – Key Points
- If you become a sole trader (or if there are two or more people running the business – a partnership), it is very easy to get started. All you need to do is register as self employed with HMRC.
- To set up a limited company, you need to choose a company name, and submit incorporation information to Companies House (the registrar of all companies in the UK) before you can start up.
- As a limited company director, you have a number of statutory and legal responsibilities, which sole traders don’t share, and you have certain obligations under Company Law.
- If you are self employed, your liability if things go wrong with your business, is unlimited. Your personal finances are also alongside your business finances.
- On the other hand, a limited liability director’s liability is limited to the amount of equity you have put into the company should things go wrong. The company is a completely separate entity from the individual members who own it.
- The self employed work out their tax via the annual self assessment process – your business and personal income and expenditure are treated as one.
- Limited companies have to pay Corporation Tax on their profits – the rate is currently 20% (the ‘small companies tax rate’).
- As the tax affairs of limited companies are more complex, you will typically pay more in accounting fees than you would as a sole trader or partnership.
- Limited companies must prepare annual accounts for submission to HMRC and Companies House. Sole trader accounts are not submitted to HMRC, and are more basic to prepare.
- Shareholders draw down income from limited companies via dividends, which is a tax efficient way of receiving income, as National Insurance Contributions are not payable on dividends.
- Sole traders and members of a partnership pay Class 2 and Class 4 NICs on their income, together with income tax.
- If you are an employee of a limited company, you pay income tax, and Class 1 NICs (if your salary is greater than the prevailing threshold to pay National Insurance).
- As an employer, the limited company is also liable for employers’ Class 1 NICs on the salaries it pays to staff.
- Tax planning is more flexible if you are a limited company owner, as you can postpone declaring dividends until a later tax year, in order to use your tax allowances in an efficient way.
- The self employed can have pensions, however limited company pension schemes can have more benefits and the contribution limits are higher.
- In some industries and professions, you must be a limited company to trade (such as computer consultants). In others, it may present a more professional image if you own a company.
- There is more administration associated with running a limited company, in terms of accounting and dealing with Companies House.
- If you want to sell part of your business to a new partner or investor, the process is cleaner and more attractive to a potential newcomer, if you are incorporated.
Which structure is best for you?
In summary, the limited company route affords limited liability for its members, it is the more tax efficient route to take, but involves more administration than the self employed route.
Becoming self employed is an easier process, and aside from keeping your tax records in order, this is a more flexible route to take for many.
It is important that you take some time before deciding which route is best for you, and we would advise you discuss your options with an accountant.