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Sole Trader vs Limited Company

Sole Trader or Limited Company: Which is best?

Editorial Team

Every new business needs to register a legal structure, no matter its size. The choice to be either a sole trader, partnership, limited liability partnership, or limited company is influenced by many factors, like your overall earnings and tax payments.

Read on to learn about being a sole trader vs limited company and the advantages and disadvantages of both, before making a decision to register your business.

Before you begin

If it's fair to say that you are your business, registering as a sole trader would make this official from a legal point of view. You are the sole owner of your business and the money your business makes and spends equals your personal finances.

As a partnership is basically the same as a sole trader with the sole difference that you would be sharing your business with partners and / or co-founders, this article mainly focuses on the differences between sole traders and limited companies.

In contrast to the sole trader or limited liability partnership, when you set up a limited company you and your business become separate entities. Even if you founded the business, you are now working for the company, which means that all the money, profits included, belong to the business and not to you.

Sole trader advantages

  • Registering - setting yourself up as a sole trader involves little paperwork because you will only need to register with HMRC as self-employed for tax purposes, making the process rather easy and straightforward.
  • Privacy - as a sole trader business you have far more privacy than a limited company, as you will not have to register with Companies House which would make the details of your business public.
  • Profits - as a sole trader business your expenses are tax-deductible which means that only your profits are taxed. Your earnings are entirely dependant on your performance.
  • Tax - as a sole trader business you pay income tax at the standard rate and you will contribute to National Insurance on all profits. On top of that, you will only need to send to HMRC a self assessment tax return for every tax year. There are no requirements regarding government reporting or financial accounting.

Sole trader disadvantages

  • Liability - because there is no legal difference between you and your company, you are faced with unlimited liability. This means that you become personally liable for any company debt and legal costs if sued or when taken to court. If anything goes wrong, you can lose your personal assets, which is why sole traders are generally advised to seek public liability or professional indemnity insurance to protect themselves. Please bear in mind that all businesses need insurance, no matter their legal structure.
  • Funding - this can be tricky as banks and investors often prefer working with limited companies rather than with small businesses, which can limit your expansion opportunities.
  • Tax - although there are advantages, you may find that when you reach a certain level of earnings, tax rates will be less in your favour and it might not be as cost-effective to operate as a sole trader, as paying corporation tax is usually kinder on business owners. On top of this, tax relief on interest loans and bank overdrafts are restricted for sole traders.

Limited company advantages

  • Liability - registering as a limited company gives you limited liability, which means that because your business is a separate legal entity to you, you will not be held liable for any business debts. Your personal assets aren’t at risk and, in a worst-case scenario, you only lose whatever you put into the business.
  • Protection - when you register as a limited company, the name of your business is protected, meaning that no one else can use it.
  • Tax - as a limited company you pay corporation tax on your profits rather than income tax and National Insurance, which can be more profitable than operating as a sole trader. It is also more tax efficient to pay out dividends to shareholders as it gives individuals a greater overall tax-free allowance, considering that the first £2,000 of dividend pay out is tax-free. Bear in mind that if you do receive dividends on top of your personal allowance, you will need to complete a self assessment tax return for every tax year and submit to HMRC.
  • Profits - as a limited company you can claim tax relief from a wider range of allowances and tax-deductible costs against your profits.
  • Investment - you can re-invest business profits back into the company without being personally taxed on them first.

Limited company disadvantages

  • Registering - it can be costly and time-consuming to set up your business as a limited company, and you may wish to hire an accountant to help with all the extra paperwork. You will also need to keep Companies House informed of any changes about your business, like, e.g., a change of address or a change in directors, as this is a legal requirement under the Companies Act.
  • Responsibility - you will find yourself with far more legal duties as a limited company, which need to be fulfilled in order to comply with the companies act and tax purposes. You will have to appoint at least one limited company director, who becomes liable for the company meeting all its legal responsibilities, like keeping company records, filing annual accounts, and making a Company Tax Return.
  • Privacy - all your company’s details, including details on the directors and the annual profits, will be shown publicly.

Bottom line

It ultimately comes down to your personal business goals: do you prefer operating as a small business with control over your earnings and unlimited liability, or are you ambitious in the sense of developing a larger company?

It’s worth noting that you can always change your business structure down the line, although it is far easier to switch from a sole trader to a limited company. If you were to switch from a limited company to a sole trader you would have to dissolve your business and that can be a rather complicated process. Don’t feel like you have to rush into a decision and speak to an accountant if you want more assurance.