Sole Trader vs Limited Company: The Best Option for Your Small Business

by | Sep 20, 2019

Sole Trader vs Limited Company: The Best Option for Your Small Business

A major decision that you must make regarding your business is the form of legal entity it will take. To a large degree, this decision may be dictated by the way you have organised your operations and whether you intend to work on your own or in conjunction with others. Ultimately, the best option depends on what you want from your business.

The form of entity you choose can have a significant impact on the way you are protected under the law and the way you are affected by taxation rules and regulations. There are four basic forms of business organisations. This blog post will focus on sole traders (also known as a sole proprietorship) and limited companies and the pros and cons associated with each.

What is a sole trader?

A sole trader typically describes any business that is owned and controlled by one person. The profit or loss of a sole proprietorship is combined with the other income of an individual for income tax purposes.

Advantages of being a sole trader

  • Quick and easy to set up.
  • Full control of the business can be maintained and ran without interference from others.
  • All profits can be retained.
  • Information regarding sole traders is kept private, unlike limited companies which must make their accounts public upon registration with Companies House (however, this is only short-set accounts and therefore should not be a determining factor in becoming a limited company).
  • Currently, there is no legal requirement that sole traders need to prepare accounts for tax purposes. However, in April 2020 (at the earliest) – HMRC will implement Making Tax Digital for Income Tax and Corporation Tax. Self-employed people and landlords can currently sign up for the Income Tax pilot, instead of filing Self Assessment returns.

Disadvantages of being a sole trader

  • Sole traders do not have a separate legal entity and as a result have unlimited liability. Therefore, the owner is personally liable for any and all debts generated by the firm.  This means that the owner can risk their home, assets and personal savings from within the business and out with the business, if they are required to pay a significant debt.
  • Banks are less likely to lend to a sole trader than a limited company. This reduces sole trader expansion.

What is a limited company

A limited company is a separate legal entity that exists under the authority granted by statute. A limited company has substantially all the legal rights of an individual and is responsible for its own debts.

Advantages of a limited company

  • Banks often perceive limited companies as safer and more reliable. Therefore, finance is more readily available to limited companies in comparison to sole traders.
  • Likely to pay less personal tax than as a sole trader. Typically, we advise that if your business generates £25,000-£30,000 turnover you should move to a limited company for the tax savings to be worth it, alongside the increased accounting costs. To learn more read Directors Salary and Dividend 2019/20.
  • Limited companies offer reduced responsibility for your business debt. This means the owners or shareholders of a limited company are protected from the liabilities of the business. However, when a limited company is small, creditors often require personal guarantees of the principal owners before extending credit.
  • Generally, this prevents the owner from being sued. For this reason, it is recommended to become a limited company when employing staff.
  • A wider range of expenses can be claimed. Anything classed as a genuine business cost can be claimed back on expenses. Read What Expenses Can I Claim Through a Limited Company.
  • Benefit from the Flat Rate VAT Scheme. Learn more at Flat Rate VAT – The New Percentage for Limited Cost Businesses.

Disadvantages of a limited company

  • More paperwork and extra range of legal duties.
  • Annual accounts must be prepared under the provisions of the Companies Act and in accordance with accounting standards. Changes to how these will be reported for limited companies will change from April 2020 with the introduction of the government initiative Making Tax Digital.

Key differences of Sole Traders and Limited Companies

The key differences between sole traders and limited companies are:

Sole Trader
Limited Company
Class 2 & 4 NIC and Income Tax on Profits.
The company pays corporation. Shareholders are subject to income tax or dividends.
You are personally liable for all debts.
Your liability is limited to the amount unpaid on your shares and any personal guarantees.
No requirement that you prepare accounts just Self Assessments and no disclosure.
Must prepare annual accounts under the provisions of the Companies Act. Accounts to be submitted to HMRC.
Selling the business
When the business or assets used in it are sold, you are personally taxed on any gain under the Capital Gains Tax (CGT) rules.
When the business or the assets used in it are sold, there is a double tax charge on shareholders. The company pays corporation tax on any profit that it makes on disposal. The shareholders are taxed on the distribution of the proceeds.

GrowFactor offers support and specialised packages to both sole traders and limited companies. To book a free consultation with GrowFactor to discuss the best option for your business, please book in below. 

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