Tax Guides

Sole Trader vs Limited Company

Sole Trader vs Limited Company

February 22, 2022

One of the first decisions you’ll have to make when starting your own business is whether you want to operate as a sole trader or limited company. The Office of National Statistics reported that there were 5.6 million registered businesses at the beginning of 2021. Out of those, 3.2 million (56%) were sole traders, 2 million were registered limited companies (37%) and 384,000 (7%) were ordinary partnerships. So, whilst being a sole trader may be the most popular choice, limited companies follow closely, and this guide will explain why. There are advantages and disadvantages to both business structures which should be considered before making a decision.

What is a sole trader?

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A sole trader, also known as a sole proprietorship, is the most basic type of business structure. Your status is defined as being self-employed, and you must report this to HMRC when you begin running your business in this manner. Operating as a sole trader means you are wholly responsible for your income and taxes, as you have no employer who would ordinarily take care of this for you if you were an employee. Not only this, but you are personally responsible for all successes and failures of your business. Should your business run into financial trouble, you need to be aware that there is no protection from debt collectors seizing personal assets such as your car, home, or cash from personal bank accounts. This is because there is no separation between you and your business.

What is a limited company?

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A limited company is a corporate structure with its own legal identity, distinct from its owners (the shareholders) and managers (the directors). This remains the case even if it’s run by just one person, acting as both shareholder and director. A company therefore holds its own assets, takes on its own debts, has its own earnings and tax liability, separate to the people who own or run the company. In other words, there is limited liability, and shareholders and directors are not personally at risk (unless the business failings are due to their gross misconduct). As a result, it also means that shareholder and directors are unable to withdraw funds from the company at their own discretion and must follow formal procedures in order to do so. Unlike operating as a sole trader, there are also additional legal annual filing requirements with Companies House which must be completed.

Advantages of operating as a sole trader

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Possibly one of the main reasons why a majority of registered businesses choose to operate as sole trader status is the ease and simplicity. Some of the advantages to operating as a sole trader include:

  • Being able to start your business straight away
  • No fees to pay when you register your business as you do not need to register with Companies House
  • You only file one self-assessment tax return a year which covers your business and yourself so there is far less administrative responsibilities
  • You have complete control over your business with no formal rules to follow
  • You have more privacy as information on your business does not have to be published publicly on Companies House
  • Accounting costs are often lower as most business ran as a sole trader are relatively small, and this business structure is best suited for early-stage businesses just starting out
  • It is fast and easy to close the business down as a sole trader

Disadvantages of operating as a sole trader

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Despite the many conveniences, there are also limitations which some will see as disadvantages to operating as a sole trader, such as:

  • Unlimited liability, which means that you are liable to personally cover any debts or losses of your business
  • Increased difficulty when it comes to securing finance for your business, as many banks and lenders will not be willing to lend large sums of money to sole traders
  • Customer perception can be harder to change as many people will take the view that sole traders are less credible than limited companies and therefore may prefer to work or purchase from limited companies instead
  • Similarly, many businesses will often only work with limited companies, so you could be missing out on potential business as a result of operating as a sole trader
  • There are fewer opportunities to reduce your tax liability using efficient tax strategies because the entirety of earnings made will be subject to income tax online
  • There are many generous tax-advantageous schemes offered by the government such as SEIS, EIS, R&D credits and EMI share schemes which are only available to limited companies so you are restricted in you ability to access these

Advantages to operating as a limited company

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Although not as simple as starting a new business as a sole trader, many people choose this option for the benefits and advantages of operating as a limited company including:

  • You are protected by limited liability which means only money you choose to put into the company, and money that is made by the company is at risk of loss
  • Limited companies often benefit from the reputation of being less risky to work with or buy from than sole traders as many customers feel there are more reliable recourses if they are dissatisfied with a product or service, so you may be able to grow your business faster and easier than as a sole trader
  • Your company name is legally protected and cannot be used by another business
  • You have increased chances of securing finance from investors and lenders as a limited company compared to sole traders
  • As a shareholder of your limited company, you are entitled to receive dividends. This means you can receive up to £2,000 in dividends tax-free and all dividends received in addition to this threshold is taxed at a lower rate than income tax.
  • There are increased tax planning opportunities including re-investing profits into the business to reduce corporation tax, making family members shareholders to issue dividends and reducing National Insurance contributions by paying less salary and more dividends.

Disadvantages to operating as a limited company

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On the other hand, for many it can seem that there are much greater burdens and disadvantages to operating as a limited company such as:

  • You need to register your company with Companies House before you can start your business, and this also attracts a fee to pay
  • There are certain rules to follow when naming your company and you cannot use a name if someone has already registered their business with the name you want to use
  • You have less privacy as your personal details and company details need to be publicly published and annually updated on Companies House
  • Withdrawing money from the company for your own personal use is not as easy to do as if you were a sole trader
  • There are increased legal obligation including filing a company tax return, annual accounts and confirmation statement which also means there are more deadlines to be aware of
  • Accounting can become much more complex depending on your business and therefore could mean increased costs of using an accountant
  • It can be difficult and expensive to close down a limited a company if you no longer want to run the business as this structure

Do I pay more tax as a sole trader or limited company?

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In addition to the benefits and drawbacks of both business structures, another consideration you may want to make before deciding how to run your business is how much tax you could save depending on the business structure. We have provided a comparison table below:

2021/22

Profit Level

£10,000

£20,000

£30,000

£40,000

£50,000

£75,000

£100,000

Sole Trader

£198.00

£2,583.48

£5,483.48

£8,383.48

£11,283.48

£21,748.38

£32,248.38

Limited Company

£220.00

£2,369.00

£4,876.00

£7,384.00

£9,891.00

£19,200.00

£30,531.00

Saving

-£22.00

£214.48

£607.48

£999.48

£1,392.48

£2,548.38

£1,717.38

2022/23

Profit Level

£10,000

£20,000

£30,000

£40,000

£50,000

£75,000

£100,000

Sole Trader

£175.00

£2,687.10

£5,712.10

£8,737.10

£11,762.10

£22,539.50

£33,352.00

Limited Company

£171.00

£2,364.91

$4,973.66

£7,582.41

£10,191.16

£19,265.29

£30,849.66

Saving

£4.00

£322.19

£738.44

£1,154.69

£1,570.94

£3,271.21

£2,502.34

*Please note that new corporation tax rates are due to start for the 2023/24 tax year, starting 6 April 2023. The table above will therefore still be accurate for limited companies with a year end date of up to 31 March. 

In general, our advice would be to consider operating as a limited company once you profit levels reach £50,000 and above in order to make use of efficient tax strategies to minimise on your tax liability. Below this profit level, operating as a sole trader would offer more tax savings. It is also much simpler to transfer your business from a sole trader to a limited company than the other way around. Should you need help setting up a limited company, please do get in touch for a free consultation to discuss how we can support your new business. 

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