• Jane Wu LLB ACA

Sole Trader vs Limited Company

Updated: Jul 23


What are the key differences between a Limited Company and a Sole Trader or Freelancer?


If you are starting up a new business, this is one of the early decisions you will have to make so it's worth knowing a little bit about the key differences and what your responsibilities are as a business owner under each model.


Liability

As a sole trader you and the business are legally meshed. This means you are personally responsible for anything which might go wrong, including any debts of your business. A limited company on the other hand has it's own separate legal existence. A limited company set up creates a divide between your personal affairs and your business affairs meaning if the company fails your personal assets are not a risk to pay its debts.


Tax

A limited company pays Corporation Tax on it's taxable profits. A sole trader pays income tax via self assessment on any profits of the business. There a different rates and thresholds


Money for you

For a sole trader the money generated by the business is your money (which is why it's taxed on your personal self assessment tax return). Money generated by a limited company however belongs to the company. The company determines what to do with it. This might include re-investment in the business, distributing profits to shareholders via dividends and of course paying it's employees. For these purposes a Company Director is also an employee so as a business owner you have two key ways of extracting money. Dividends and Salary (plus potentially employee benefits). These have different tax rates and thresholds.


Sole trader

Pays Income Tax and National Insurance through the personal Self Assessment Tax Return


Limited Company Director

The Director pays Income Tax and National Insurance through Self Assessment on Salary and Dividends received from the company. The Company pays Corporation Tax on its taxable profits (after salaries and employers National Insurance).


Paperwork & Privacy

A limited company has to maintain certain information with Companies House which may be publicly available. This includes:

  • The companies articles of association

  • An annual return and an annual set up accounts or financial statements

  • A record of the companies Directors and other key officers

  • A record of the Companies Shareholders

  • A quarterly 'confirmation statement' to confirm no change in the data held at Companies House (or to update if it has)

The annual accounts must comply with the relevant accounting standards. In addition, key decisions of the company must be evidenced in formal Minutes of Directors meetings.

A sole trader does not have to maintain any information at Companies House, although in practice annual accounts are usually prepared to support the calculation of the of the self assessment tax return and may also be required by banks and other lenders when borrowing is required.


Credit Rating

A limited company establishes its own credit rating distinct from that of the business owner / Director. This potentially means greater borrowing power for the business under a limited company model if your individual credit rating is poor.


Business Expenses

Both sole traders and limited companies can claim business expenses which reduce taxable profits and therefore the tax bill. However the rules are not exactly the same. Generally speaking you can usually claim more through a limited company, but either way you will need to comply carefully with the relevant HMRC guidance. Your accounting fees can be claimed under either model.


Credibility

Occasionally there are clients (perhaps large corporations) who will only deal with a limited company. There is also a 'veneer of professionalism' afforded to limited companies which may make the business a more attractive prospect to a client. This depends on a large extent on your trade and the expectations of the market place.


Conclusion

A limited company set up can result in a lower overall tax burden as there are more options in what to do with profits. However with more options come more complexity which often means a higher administrative cost. But the decision should not be based on tax alone. Consider carefully the relative pro's and cons of having your business affairs legally separated from your personal ones as well as the expectations and requirements of your key stakeholders. Still confused? Give us a call on +44(0)7584621625.


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