What is better a Sole Trader or a Limited Company?

5th June 2023

Deciding whether to be a Sole Trader or a Limited Company is a critical decision for entrepreneurs and business owners. One common dilemma they face is choosing between operating as a Sole Trader or incorporating as a Limited Company. This choice can be made at the outset or even after the business has begun operations. We’re no experts however it is a bridge we crossed many moons ago, and is occasionally a question we get asked from friends, family and new businesses. So here is our take on things.

Key Differences Below, we outline the primary characteristics of each business model:

Sole Trader

No official registration needed, simply inform HMRC before October 5th of your second tax year.
Business is conducted under your personal name, for example, “Jane Doe” trading as “Superior Design Services.”
Unlimited liability means your personal assets are at risk if the business encounters financial problems.
Sole Traders must file a self-assessment tax return and pay income tax on declared profits.

Limited Company

All UK Limited Companies must register with Companies House.
A Limited Company is a distinct legal entity, and all business is conducted under the company’s name, not the owner’s name.
Financial liability is limited to the company.
Limited companies require bank accounts in the company’s name; personal accounts cannot be used for company transactions.
Limited companies must file annual accounts and a CT600 tax return with HMRC. Corporation tax is paid on company profits.
Company owners pay income tax on any withdrawals from the company.

A Tough Choice: Sole Trader or a Limited Company?

Advantages of Becoming a Limited Company

We’ll discuss some significant benefits of operating as a Limited Company:

Limited Liability: This aspect is often the most attractive to new businesses. Since a Limited Company is a separate legal entity, its assets, liabilities, profits, and losses are independent of its owners. If the company faces financial issues, the shareholders’ personal assets are protected. In contrast, for a Sole Trader, the owner and the business are one and the same.

Credibility Limited: Companies tend to inspire more confidence among clients, suppliers, and creditors than Sole Traders. As a business grows, it usually becomes a Limited Company. These companies are required to file annual accounts, providing greater transparency and easier assessment of creditworthiness.

Tax Advantages: Although not as numerous as before, tax benefits still exist for Limited Companies, depending on the size and nature of the business. A Limited Company offers more tools to reduce tax liability and allows owners more control over their personal tax situation by choosing when and how much to draw from the company. Sole Traders, on the other hand, have all profits subject to income tax.

Ease of Registration: Registering a Limited Company in the UK is straightforward and can be completed online, typically within 3-4 working hours. QuickFile offers an online registration service starting at £13.99 + VAT (at the time of print). For more information, consult their Company Registration FAQ.

Should I change from sole trader to limited company?

Transitioning from a sole trader to a limited company can be beneficial in some cases. If your business is growing, you may find the limited liability, enhanced credibility, and potential tax advantages of a limited company structure more attractive. Before making the switch, consider the additional administrative responsibilities and consult with an accountant to ensure it’s the right move for your business.

Why is an Ltd less risky than a sole trader?

This refers to the “Limited Liability” section referenced above. A Limited Company (Ltd) is less risky than a sole trader primarily because of limited liability. An Ltd is a separate legal entity from its owners, which means that the owners’ personal assets are protected if the company encounters financial difficulties. In contrast, sole traders face unlimited liability, putting their personal assets at risk in the event of business debts or legal issues.

Advantages of Remaining a Sole Trader

Here, we’ll examine some key benefits of operating as a Sole Trader:

Simplicity The primary advantage of a Sole Trader is its simplicity. You can decide to start your business one day and begin operations the next. You must notify HMRC of your self-employment, which can be done anytime up to October 5th of your business’s second tax year. Tax years run from April 6th to April 5th.

Reduced Filing Obligations Sole Traders declare their taxes through the Self Assessment system once a year. Limited companies must file corporation tax returns and require directors to file self-assessment tax returns as well. Sole Traders have less administrative burden in this regard, but recent years have seen simplification in filing duties for small Limited Companies.

Tax Advantages There are specific tax benefits for Sole Traders that can be beneficial, depending on individual circumstances. Unlike Limited Companies, Sole Traders can offset trading losses against other income. This can be advantageous if you anticipate short-term losses in a new business venture while still maintaining full-time employment. However, since the 2013/2014 tax year, caps have been introduced that limit the amount of trading losses you can offset.

Limited Company Filing Requirements Limited Companies must submit several essential documents annually to remain in good standing:

Annual Company Accounts These accounts must be filed with Companies House yearly, typically within nine months of the company’s financial year-end. Smaller companies only need to submit an abbreviated balance sheet and are not subject to audits. A small company is defined as one with a turnover of GBP 6.5 million or below.

Should I change from a limited company to a sole trader?

Whether you should change from a limited company to a sole trader depends on your specific circumstances and objectives. There are situations where making the switch might be beneficial. Here are some factors to consider when contemplating the change:

Simplification: If you’re seeking to reduce administrative tasks and paperwork associated with running a limited company, transitioning to a sole trader could be a suitable option. Sole traders have fewer filing obligations, which can save time and resources.
Tax benefits: In some cases, being a sole trader can offer tax advantages, such as the ability to offset trading losses against other income. It’s essential to consult with an accountant to understand the tax implications of transitioning from a limited company to a sole trader.
Reduced compliance burden: Limited companies are subject to more stringent reporting and compliance requirements. Transitioning to a sole trader can alleviate some of these obligations, allowing you to focus more on the operational aspects of your business.

However, before making the switch, keep in mind that you’ll be giving up the limited liability protection offered by a limited company, which means your personal assets will be at risk in case of financial difficulties or legal issues. Moreover, the perceived credibility and professionalism associated with a limited company may be lost if you change to a sole trader.

It’s crucial to weigh the pros and cons and consult with a financial advisor or accountant to make an informed decision based on your specific situation and business goals.

Does VAT apply to both Limited companies and sole traders?

Yes, unfortunately the tax man will be waiting at your door no matter which option you choose, at least that’s the case here in the UK. VAT is a tax on the sale of goods and services, and it is charged at various rates depending on the nature of the product or service being sold.

Regardless of the business structure, if your taxable turnover exceeds the VAT registration threshold of £85,000 (this is fixed now until 31 March 2024), you are required to register for VAT with HMRC. Once registered, both limited companies and sole traders must charge VAT on their sales, submit VAT returns, and pay any VAT due to HMRC.

Keep in mind that certain goods and services are exempt from VAT or charged at a reduced rate (you can read more about that here). If your business operates below the VAT registration threshold, you can still voluntarily register for VAT if you believe it will be advantageous for your business. In any case, it’s essential to consult an accountant or tax advisor to ensure you are compliant with VAT regulations and understand the implications for your specific business circumstances.

Setting up a new Company?

Whilst we can’t help with the above decision or the formation of your business should you chose that route, we can help with many other key components, especially those of a more digital nature. Things we can help you with: