Sole Trader vs Limited Company
Introduction
At some point most business owners and entrepreneurs need to make the decision whether to carry on their business as a Sole Trader or to incorporate as a Limited Company. This decision can be made before a single penny is transacted or later down the line.
Key Differences
Here are the key features of each trading model:
Sole Trader
- No formal registration process, simply notify HMRC before 5th October of your second tax year.
- Business is conducted under your own name, i.e. “John Smith” trading as “A1 Design Services”
- No limitation of liability, if the business runs into financial difficulty your personal assets are at risk.
- The Sole Trader must file a self assessment tax return and pay income tax on the reported profits.
Limited Company
- All UK Limited Companies are registered at Companies House.
- A Limited Company is a separate legal entity, all business is conducted in the name of the company not the name if its owners.
- Financial liability is limited to the company.
- Limited companies must have bank accounts registered in the name of the company, personal bank accounts cannot be used for Limited company trading.
- Limited companies must file annual accounts and a CT600 tax return with HMRC. Corporation tax is paid on the company profits.
- The owners of a company pay income tax on any drawings made from the company.
What are the advantages of becoming a Limited Company?
Here we’ll break down some of the key advantages to trading as a Limited Company:
Limited Liability
In most cases it is the Limited Liability aspect itself that is most appealing to new business startups. As a Limited Company is a separate legal entity it has its own assets and liabilities, profits and losses, completely separate from that of its owners. This means if the company runs into financial difficulty, the personal assets of its shareholders cannot be used to meet the debts of the company. For a sole trader the owner and the business are one and the same.
Reputability
A Limited Company will usually instill a little more confidence amongst its clients, suppliers and creditors when compared to a sole trader. Once a business reaches a certain size they will almost always be trading as a Limited Company. As Limited Companies are required to file annual accounts there’s also a greater degree of transparency as a 3rd party can access these accounts and more easily assess a company’s creditworthiness.
Tax Advantages
Admittedly the tax advantages of trading as a Limited Company aren’t as numerous now as they once were. Any tax advantages will very much depend on the size and nature of the business, a Limited Company however may give you a few more tools which you can use to minimise your tax liability. As a Limited Company is a separate entity then you will also have more granular control over your own personal tax position by deciding when and how much to draw down from the company. This is unlike a Sole Trader where all profits are calculated and subject to income tax.
Ease of Registration
It’s very simple to register a Limited Company in the UK. The process can be done online and will typically take 3-4 working hours before a company registration number is issued. If you need help registering your company QuickFile provide an online service starting at £13.99 + vat. You can find out more about this in our Company Registration FAQ.
What are the advantages of remaining as a Sole Trader
Here we’ll break down some of the key advantages to trading as a Limited Company:
Simplicity
Without doubt the main advantage of trading as a Sole Trader is the simplicity factor. You can decide one morning to start your own business and be trading by the afternoon. You will need to notify HMRC if you become self employed, you can do this at any time up to 5 October of your business’ second tax year. A tax year runs from 6 April to 5 April.
Fewer filing responsibilities
When you are a Sole Trader you would declare your tax via the Self Assessment system, this is done once per year. Limited companies must file corporation tax returns as well as requiring the Directors to also file a self assessment tax return. In terms of the administration overhead, Sole Traders do have a slight advantage here. With that said significant progress has been made over recent years to simplify the filing duties for small Limited Companies.
Tax Advantages
There are certain tax advantages of being a Sole Trader that can be beneficial depending on your circumstances. Unlike Limited Companies a Sole Trader can offset trading losses against other income. This may be advantageous if for example you expect to make a loss on a new business venture in the near term while still in full time employment. Since 2013/2014 there are now caps that limited the amount of trading losses you can offset.
Limited Company Filing Requirements
A Limited Company must file a number of important documents each year to remain in good standing.
Annual Company Accounts
Annual company accounts are filed with Companies House once per year. They would normally be submitted within 9 months of the company’s year end date. Smaller companies need only file an abbreviated balance sheet with Companies House and do not require an audit. A small company is defined as a company with a turnover equal to or below GBP 6.5 million.
Corporation Tax Return (CT600)
A Corporation Tax Return (CT600) must be filed with HMRC once per year. The CT600 is usually due within 12 months of the company’s year end date. The Corporation Tax return is a computation of the company’s taxable profits and any associated Corporation Tax this would give rise to.
Confirmation Statement
This is a very simple return filed with Companies House that acts as a checklist to verify that the company particulars remain the same. This would include things like the registered office address, directors, secretaries, shareholders and People with Significant Control (PSCs). You can find out more about the Confirmation Statement here.
Protecting a Company Name
When you register as a Limited Company your chosen name will appear on the Companies House register. The same name cannot be registered again and there are further restrictions on close match names, i.e. with pluralisation or added punctuation.
Registering at Companies House is a good way to protect the company name, although anybody wishing to obtain a higher level of protection should consider obtaining a Trade Mark. A Trade Mark has a wider scope and can protect a trading style or brand name beyond the registered name at Companies House.
You can register a Trade Mark with the Intellectual Property Office (IPO), find out more here.