Sole trader vs limited company: a comparison
Choosing the right legal structure for your business can be tricky. Here, AXA explores the differences between a sole trader and a limited company.
Whether you’re a one-man band or have employees lending a helping hand, businesses large and small need the right legal structure to help them operate effectively.
But given that the legal structure you choose can impact everything from the tax you’ll pay to your take-home wage, working out what option is best for your business can be daunting.
The most popular legal structures in the UK are sole trader and limited company. To help make the choice between running your business as a sole trader or limited company clearer, AXA explores the ins and outs of each business structure, so you can weigh up your options and decide on the route that’s the best fit for you.
Let's start with some definitions
What’s a sole trader?
A sole trader is a self-employed person who is the only owner of their business. This means that there’s no legal separation between you as the business owner and the business itself. Given that you and your business are one and the same, you can keep the profits you’ve made after tax and are personally responsible for any losses your business makes.
Sole trader is the most popular type of business in the UK, with 3.1 million of the UK’s 5.5 million small businesses falling into this category at the start of 2022.
What’s a limited company?
A limited company is a distinct legal entity from the business owner that can be formed whether you’re a one-person business or have employees. By forming a limited company, you serve your business as its director.
As director, you’re responsible for the legal and financial decisions your business makes, but your business’s assets and liabilities are totally separate from your own individual finances. This means that all profits and losses belong strictly to the company, meaning you must always act on behalf of the company.
In 2022, 2.1 million businesses in the UK were limited companies.
Setting up business
How do I set up as a sole trader?
Setting up as a sole trader is relatively simple – which is likely why it’s the most popular business structure. To become a sole trader you need to have a National Insurance number and inform HMRC by registering for self-assessment if you’ve earned more than £1000 from 6th April to the 5th of April the following year.
When it comes to naming your business, you have the option to either trade under your own name or a business name. Keep in mind that when it comes naming your sole trader business, other businesses can trade under the same name as you and they’re perfectly within their rights to do so.
Choose carefully when deciding on your business’s name, especially as an error in judgement could result in your business being mistaken or associated with a business with a poor reputation or service.
How do I change from sole trader to limited company?
Most people start out as a sole trader and then form a limited company when they have a good customer base and a steady income. The process of changing from a sole trader to a limited company is relatively simple. Just follow the normal process for setting up a limited company and make sure you tell:
- HMRC: You’ll need to contact HMRC to de-register as self-employed and inform them of the change to your company structure.
- Your accountant: It’s important to tell your accountant that you’re changing to a limited company so they can adjust any tax calculations.
- Your insurance provider: If you’re changing from a limited company to a sole trader, you might need to review your insurance policy.
Transfer of assets from sole trader to limited company
If you purchased business assets when you were working as a sole trader, you can transfer them to your limited company. However, you might need to pay tax on them which is why it’s important to speak to your accountant or seek professional advice.
How do I set up a limited company?
Decided you want to set up a limited company? If you’re at least 16 years old, haven’t been prohibited by a court order from being a company director and have no history of bankruptcy, then it should be full steam ahead.
The first thing you need to decide is if you want to be a private limited company (LTD) or a public limited company (PLC). Contractors, small businesses and freelancers tend to establish themselves as private limited companies because public limited companies need to have a share capital of £50,000, a minimum of two shareholders, two directors and a qualified company secretary.
Next, you need to choose your company name. Unlike setting up a sole trader business, your company name needs to be unique – a task made a little easier by checking for available company names using the Companies House WebCheck service.
Once you register your company with Companies House, your company name is protected by law, meaning no other business can use the same name as you or anything deemed to similar. The standard online registration fee is £12, and it usually takes 24 hours for your business to be registered. You can also register by post, using an agent or through third party software.
By registering your company with Companies House, you’ll also simultaneously register your business for Corporation Tax, which needs to be in place within the first three months of starting your business. Following registration, you’ll get a ‘certificate of incorporation’, which will detail your company number and date of formation as well as acting as confirmation that your company legally exists.
Find out more information about setting up a business in our Complete Guide to Starting a Business
Liability
Where does the liability for my sole trader business lie?
In the eyes of the law, sole traders don’t have a separate legal existence from their business, meaning any business decisions, profits and debts are the responsibility of the owner.
So say for example your business was to fall into debt or fail. As the business owner you’d be personally liable, meaning you could lose personal assets if things go wrong.
Where does the liability for my limited company lie?
A limited company is a distinct legal entity from the business owner that can be formed whether you’re a one-person business or have employees. By forming a limited company, you serve your business as its director.
As director, you’re responsible for the legal and financial decisions your business makes, but your business’s assets and liabilities are totally separate from your own individual finances. This means that all profits and losses belong strictly to the company, meaning you must always act on behalf of the company.
Whether you’re a sole trader or limited company, running a business comes with loads of risks.
From professional indemnity insurance, employers’ liability insurance to public liability insurance, AXA provides a variety of covers to help protect you and your business when it needs protected most.
TAX
How do I pay tax as a sole trader?
As a sole trader, you need to pay National Insurance and submit a personal Self-Assessment Tax Return to HMRC at the end of each tax year. You can find the current tax rates and personal allowance limits here.
Failing to submit this tax return in time could result in your business facing hefty fines and penalties. Why not consider keeping a detailed account of the money entering and leaving your business throughout the year? That way you can easily calculate your business’s profits and losses, keep on top of your business’s accounts, and remain relatively stress free as the much-dreaded self-assessment deadline looms.
How do I pay tax as a limited company?
Instead of paying Income Tax and National Insurance, limited companies pay Corporation Tax on their profits. However, limited companies have different deadlines set by HMRC and Companies House which they need to adhere to.
Deadlines
After incorporating your business with Companies House, you’ll be given an accounting reference date. The first accounting reference date is the last day of the month when the first-year anniversary of the incorporation of your business lands. So, if you started your business on 7th April 2019, your accounting reference date (and end of your business’s financial year) would be 30th April 2020.
Corporation Tax
Limited companies must pay Corporation Tax on their profits. To find out more about how to pay Corporation Tax and the most up to date tax rates, visit GOV.UK
You must pay your Corporation Tax no longer nine months and one day after the end of your accounting period. And because your accounting period for Corporation Tax can’t be longer than 12 months, if it goes beyond this limit you could have two payment deadlines in your first year as a limited company.
CT600
When filing your Corporation Tax return, you’ll also need to return a CT600 form to HMRC once a year, which lists the details about your company’s income, minus tax allowances and business expenses.
P11D
Directors of limited companies need to submit P11D forms, which summarises the value of all benefits and expenses provided to directors and employees, to HMRC at the end of each tax year.
Even if your limited company consists of only you, you still need to file a P11D to HMRC and keep a copy for your own records. If no benefits are provided to any directors or employees, you can either file a nil P11D or let HMRC know.
Year-end accounts
In accordance with the Companies Act 2006 and accounting standards, details about your business’s finances need to be made accessible for the public. This means that you need to submit a yearly set of accounts to Companies House at the end of your accounting period. Your business’s year-end accounts should include the company’s statement of financial position, the company’s income statement and any relevant accounting notes.
VAT return
At the end of every quarter, limited companies need to add up the VAT they’ve added to sales and deduct the VAT they’ve paid on business expenses. The standard rate of VAT is 20%, but there are other flat rates available dependent on what industry your business is in. For the 2022/23 tax year, you must register for VAT If your company’s annual excess is more than £85,000 per year.
Self-assessment
Directors of limited companies need to submit a self-assessment of their personal income and allowances to HMRC. This personal tax return must include information about all income gained from employment, dividends paid to you by your company and additional sources of income, including rental income and sole trader income.
The deadline to file your self-assessment is the 31st of January each year, but you can submit it as soon as you get your P60 for the relevant tax year.
Salary
How do I pay myself a salary as a sole trader?
Given that there’s no legal difference between the business owner and the business itself when you’re a sole trader, you can take money out of your business as and when you need it. It is good practice to keep track of how much money you have drawn as salary as this will help keep track of your final profits for your self assessment tax return.
How do I pay myself a salary as a limited company?
As a director, you can pay yourself via a PAYE salary, which is why your company must be registered with HMRC as an employer. You’ll also have to register yourself for self-assessment to report this income to help stay in the taxman’s good books.
If you pay yourself, employees or other directors a salary that goes above the primary threshold, you’ll also have Income Tax and National Insurance contributions deducted to HMRC each pay period. These salary payments are a tax-deductible expense, so your business won’t have to pay Corporation Tax on them.
However, if your salary exceeds the secondary threshold you’ll need to pay employer’s National Insurance contributions on annual salary earnings.
As an alternative to the above, you can choose to pay yourself a salary up the annual tax-free personal allowance limit. The rest of your income can be taken as dividends – the money a company has left over after paying all business expenses, liabilities and taxes – of which the first £2000 are tax free.
As company director, you can choose to leave dividends in your business to help build it up or you can choose to take your share of these business profits as dividend payments. If you’re the sole shareholder in your business, you’re entitled to get all remaining profit after costs, expenses and tax.
Bear in mind that if you make a mistake when reporting your income, your business could face penalties from HMRC. As company director, it’s a good idea to keep your business accounts organised and up to date so that you can help prevent your wallet being hit by unexpected costs.
Legal
Who is legally responsible for my sole trader business?
Given that there’s no legal distinction between a sole trader and their business, if your company is involved in a legal dispute, you’ll be sued personally for any reparations. This could lead to a loss in your personal assets.
Who is legally responsible for my limited company?
As the director of your limited company, you’re legally obliged to adhere to the Director’s Fiduciary Responsibilities. As fiduciaries, directors are held to a higher standard of conduct than other employees within the company.
Broadly, the director’s two main priorities are to provide a duty of care and a duty of loyalty to their company.
In accordance with the ‘Enlightened Shareholder Value’, limited company directors are required to:
- Act within their powers
- Promote the success of the company for the benefits of its members as a whole – When making decisions, directors must consider the potential long-term consequences for the company, the interests of employees, company reputation, the promotion of good relationships with suppliers and customers and the company’s impact on the environment and local community
- Use independent judgement
- Exercise care, skill and diligence
- Avoid conflicts of interest
- Not accept benefits from third parties
If directors fail to the adhere to the duties listed above, which leads to shareholders or creditors experiencing a loss or reputation damage, directors can face serious consequences. These repercussions range from being stripped of your role as company director to facing a court order for the business to get financial compensation, which could result in personal bankruptcy.
Expenses
How do I claim business expenses as a sole trader?
As a rule of thumb, you can only claim for expenses that are incurred wholly and exclusively for the purposes of your business trading.
For assets that you use for both personal and business purposes, you can only claim the expenses occurred for business use. For example, if you have a mobile phone bill that costs £100 but you only use it for business use 25% of the time, you’d only be able to claim for £25 as an expense.
Find out exactly what you can claim as allowable expenses here
How do I claim business expenses as a limited company?
In the same vein as sole traders, you can claim expenses for your limited company if they’ve been made wholly and exclusively for the purpose of keeping your business trading. Claiming allowable expenses as a limited company reduces the amount of profit you’ll pay Corporation Tax on.
How you decide to claim expenses is totally up to you. You can either choose to pay your business’s expenses straight from your company account or claim them back as reimbursed expenses if you’ve paid for them personally.
If you have any employees, it could be a good idea to consider implementing a company expenses form and policy so you can keep on track of everything.
Find out exactly what limited companies can claim as allowable expenses here
Privacy & Transparency
Does information about my sole trader business need to accessible by the public?
Sole traders can operate completely privately and aren’t required to make their information on business accounts, records, directors and shareholders private.
Does information about my limited company need to accessible by the public?
Limited companies are required to be transparent by law. Information on company records, accounts, directors and shareholders needs to be shared on public registers at Companies House. This information is published and can be accessed by anyone.
As well as providing HMRC with financial information to keep your tax on tracks, limited companies are also required to submit a confirmation statement to Companies House. Confirmation statements detail information about your business, its directors, shareholders and other individuals of significant control involved with your company.
Failing to file a confirmation statement each year has serious consequences. Companies House could assume that your business is no longer operating and attempt to strike it from the register. When a business is struck off the registrar, it ceases to exist and its assets become Crown property.
Whether you decide to run your business as a sole trader or a limited company, each legal structure comes with its own unique set of advantages and disadvantages. But the option that’s right for you depends on the size, nature, goals and industry your business belongs to.
It’s important not to rush into any decision. Spend some time researching the legal structure that’s the best fit for you and chat to accountants and other business owners to get their view points before taking the leap.