BJT Accountants Logo
BJT Accountants Logo

Limited Company V Sole Trade

In my 12 years in the accounting profession the most popular question I hear (apart from how much tax do I owe?) is whether or not to “Go Limited”.

It is a vital question and the route you decide to go down can affect greatly your financial responsibilities and how you are taxed and so requires a great deal of thought and planning.

What is a sole trader?

This is the simplest structure when establishing a business, and appeals to many businesses who are just starting out. A sole trader is essentially a self-employed person who is the sole owner of their business.

The fact that it’s the most straightforward structure you can get in the UK is probably why it’s the most popular at the same time.

You will need to officially set yourself up as a sole trader for tax purposes with HMRC and let them know when you start to trade.

Pros:

  • There’s no requirement to make your details public. You do not have to file a set of accounts for public record and will only have to file a tax return with HMRC. You will still need to draw up a set of accounts as the figures from these will flow into your tax return.
  • It’s easy to set yourself up as a sole trader and there’s relatively little paperwork throughout the year, other than the annual self-assessment tax return.
  • There’s more freedom on how you run your business — The Companies Act governs how a Limited Company can be run and imposes certain laws and restrictions. As a sole trader, you will not be subject to these regulations.
  • Sole traders can offset losses against other income during the year (such as employment income or bank interest), and this is not the case with Limited Companies, whom can only use up trading losses against future trading profit.

Cons:

  • There’s a higher rate of tax when you reach a certain level of earnings — 40% on income between £46,351 and £150,000 and 45% on income over £150,000.
  • You have to pay Classes 2 and 4 National Insurance. Class 2 is a set £2.95 per week where annual profits are above £6,205. Class 4 is based on the amount of profit you made that year and equates to 9% on your earnings between £8,424 and £46,350, and 2% on earnings above this.
  • Unlimited liability — You are not seen as a separate entity by UK law. This means if your business goes bankrupt, you’ll need to pay creditors from your own personal assets. Some people have lost their homes and other possessions as a result of this.
  • Raising finance can be difficult for sole traders. You’re often viewed as a risk by investors and banks, which could prevent you from growing your business.

What is a Limited Company?

A Limited Company is a type of business structure that has its own legal identity. This means it’s separate from its owners (known as shareholders), and its management, (known as directors). This remains the case even if it’s run by just one person, acting as shareholder and director.

Pros:

  • “Going Limited” can be more tax efficient. Limited Companies pay Corporation Tax on profits at a flat 19% (which is set to go down to 18% from 1st April 2020) and are not subject to National Insurance.
  • The Company will have limited liability, which means shareholders are legally responsible for the debts of a Company only to the extent of the nominal value of their shares (this can be as low as 1p). If the business goes bankrupt, your personal finances will not be affected.
  • As an owner of a Limited Company, you will have shares in the business. This means you are entitled to a percentage of what that business is worth. This will be particularly profitable for Companies that have growth potential.
  • As a shareholder of a Limited Company you will be entitled (depending on voting rights) to a share of the Company profits which is done in the form of a dividend. Dividends for shareholders are taxed at 7.5% for the basic rate of tax with the first £2,000 being tax free. Any higher rate dividends are tax at 32.5% with additional rate dividends taxed at 38.1%. Dividends are exempt from National Insurance.
  • Being Limited can often appear more credible which is a benefit when trying to generate customers as well as getting finance.

Cons:

  • From Company records to accounting and financial figures, there are a range of rules and regulations a Limited Company has to follow. These are included in the Companies Act 2006 as well as the Company’s own Articles of Association.
  • The accounts a Company will file will be on public record as they are filed at Companies House. Directors of the Company will also have to disclose their name, nationality, occupation as well as the month and year of their birth. They will also have to disclose a service address.
  • The administration is far more time consuming than it is for sole traders. Many Limited Companies opt to hire an accountant to ensure they don’t fall foul of the regulations in play such as the Companies Act 2006 as well as UK tax law. This will mean an added cost.
  • You can’t just withdraw money from the business without formally recording it as a salary, dividend or loan. Therefore, you have less freedom in how you manage your profits and how you pay yourself.
  • As a shareholder or a director, you can’t just walk away from a business — there is a range of options available for those looking to close a Company. All of them come with their own rules and processes and can be quite time-consuming.
  • Limited Companies aren’t allowed to choose cash basis accounting and so must use accrual method instead.
  • A Company will have to file a Confirmation Statement each year with Companies House. This discloses people who have significant control in the business and is an added obligation which will have to be fulfilled.

In summary a good accountant can help you to take advantage of the Pro’s above as well as mitigating the Con’s.

Anyone considering their options should always speak to their accountant first and get some specific advice based on their own circumstances. This blog is for guidance only.

We at BJT Accountants would be happy to answer any queries or concerns you may have on any of the issues raised above.

Note – The above information is based on 18/19 UK tax tables.