Sole Trader V Ltd. Company: What's the difference?

March 26, 2024

Running a business involves various critical decisions, with none more significant than choosing the right business structure.

If you’re wondering whether to set up as a limited (ltd.) company or a sole trader, the decision isn’t one to take lightly. You may be eligible for both and they each carry a range of benefits. From understanding their definitions to exploring tax obligations, it’s important to arm yourselves with as much knowledge as possible to make your business a success.

In this comprehensive guide, we’ll give you all the essential information on operating as a sole trader vs a ltd. company.

What is a sole trader?

In the UK, a sole trader is the simplest form of business structure, where one person runs a business as a self-employed entity. Operating as a sole trader involves minimal bureaucratic hurdles, so it’s an attractive option for anyone starting small enterprises. Sole traders have complete control over their businesses and retain direct access to all profits.

The process of becoming a sole trader is relatively straightforward. You must register with HM Revenue and Customs (HMRC) for self-assessment and adhere to taxation and reporting requirements. Sole traders are responsible for managing their own financial records and filing tax returns on time.

What is a limited company?

In contrast to a sole trader, a limited company is a distinct legal entity separate from its owners. It provides a higher level of protection to the owners, known as shareholders, as their liability is limited to the amount invested in the company. This structure requires formal registration with Companies House, involving the submission of various documents detailing company structure and operations.

The shareholders own the company, and its operations are overseen by directors. Limited companies are subject to corporation tax on profits, which is separate from the personal income tax paid by sole traders.

Advantages and disadvantages of sole trader’s vs a Ltd. company

If you’re wondering whether it’s better to be a sole trader or a limited company, there are pros and cons to both. Operating as a sole trader offers distinct advantages and disadvantages. On the positive side, the simplicity of setting up and managing a sole proprietorship is a major advantage. Sole traders have full control over their businesses, allowing for quick decision-making without the need for extensive consultations.

Another advantage is the direct access to profits. As the sole owner, any profits generated by the business belong entirely to them. This autonomy means efficient financial management and the ability to reinvest profits according to the owner’s priorities.

However, the most significant disadvantage of being a sole trader is the concept of unlimited liability. In the unfortunate event of business debts or legal issues, the sole trader’s personal assets are at risk, including their home and savings. This risk factor can deter entrepreneurs who want to protect their personal wealth.

Access to capital can also be challenging for sole traders, as financial institutions may see them as riskier, compared to limited companies with multiple shareholders.

Advantages and disadvantages of limited companies’ vs sole traders

Limited companies come with their own set of advantages and disadvantages. One key advantage is the limited liability protection afforded to shareholders. Unlike sole traders, the personal assets of shareholders are separate from those of the company. This provides a crucial layer of security, mitigating risks associated with business debts and legal liabilities.

Additionally, limited companies often enjoy increased credibility in the business world. This can be advantageous when attracting investors, negotiating contracts, or building relationships with clients who may prefer the stability associated with a corporate structure.

From a financial perspective, limited companies can benefit from tax advantages, such as lower corporate tax rates and the ability to optimise personal and corporate tax planning.

While there are benefits of a ltd. company vs a sole trader one, they come with corresponding disadvantages. Limited companies face more complex administrative requirements, including the submission of annual financial statements to Companies House. This increased scrutiny can compromise privacy, as financial information becomes publicly accessible. Decision-making can also be more intricate in limited companies, involving a balance between the interests of shareholders and the decisions made by directors.

Can one person own a limited company?

Yes, in the UK, a limited company can be owned and operated by a single person. They assume the roles of both the sole director and shareholder. While, as director, they oversee the day-to-day operations and decision-making, they also hold shares in the company, representing ownership.

This structure, commonly known as a ‘sole director and sole shareholder’ setup, is a popular choice for entrepreneurs who want the benefits of a limited company while maintaining complete control over the business.

While a single-person ownership structure is allowed, you should be aware of the associated responsibilities and obligations that come with being a director and shareholder. You’ll still need to adhere to the legal and regulatory requirements imposed on limited companies with more employees.

How to change from a sole trader to a limited company, or vice versa

Transitioning from a sole trader to a limited company, or vice versa, is a significant decision that requires careful consideration and proper execution. The way that you’ll do this has numerous similarities whichever way you’re switching, though there’ll be subtle differences to be aware of.

Here are the general steps involved for each.

Changing from a sole trader to a limited company

Register with Companies House: To become a limited company, you need to register with Companies House. This involves choosing a unique company name, defining the company’s structure, and appointing at least one director.

Inform HMRC: Notify HM Revenue and Customs (HMRC) about the change in your business structure. This involves updating your tax status and ensuring compliance with new tax obligations.

Transfer assets and liabilities: Transition your business assets and liabilities from the sole trader entity to the newly-formed limited company. This includes updating contracts, agreements, and informing clients or customers about the change.

Open a business bank account: Establish a separate business bank account for the limited company to keep personal and business finances distinct.

Changing from a limited company to sole trader

Inform Companies House: Notify Companies House about the decision to cease operating as a limited company. This involves filing the necessary forms and meeting the legal requirements for dissolution.

Update HMRC: Again, you’ll need to inform HMRC of the change, being aware of any tax implications that may arise during the transition.

Transfer assets and liabilities: Similar to the process of becoming a limited company, adjust contracts, agreements, and notify clients or customers about the change in your business structure.

Close your business bank account: Close the business bank account associated with the limited company and open a new one for the sole trader entity.

Seeking professional advice, especially from accountants or business consultants, is crucial during this transition to ensure compliance with legal requirements and manage potential tax implications effectively.

What do you need to know about paying tax in the UK as a limited company or a sole trader?

Understanding the tax implications of your business structure is essential for compliance and effective financial management. It may help with your research to find a ltd. company vs sole trader tax calculator online, or to proceed with seeking the advice of an accountant.

Common considerations for both structures include:

VAT registration: Depending on the turnover, both sole traders and limited companies may need to register for Value Added Tax (VAT) and submit regular VAT returns.

Record keeping: Both structures are expected to maintain accurate financial records, including income, expenses, and transactions, for tax purposes.

Tax deadlines: Both sole traders and limited companies must meet specific tax deadlines, including filing annual tax returns and paying any taxes owed on time.

Here’s an overview of the different considerations for limited companies and sole traders.

Paying tax as a sole trader

Sole traders are subject to income tax on their business profits. The profits are declared on the annual self-assessment tax return, and tax is calculated based on the individual’s total income. They are also liable for Class 2 and Class 4 National Insurance Contributions (NICs), which contribute to state benefits and pensions.

Sole traders can benefit from various tax allowances and deductions, including the Annual Investment Allowance (AIA) for eligible capital expenditure and expenses related to running the business.

Paying tax as a limited company

Limited companies are subject to corporation tax on their profits. The current corporation tax rate is applied to the company’s taxable profits. If the company distributes profits to shareholders in the form of dividends, shareholders may be liable for dividend tax. The tax rates vary depending on the individual’s overall income.

If the limited company employs staff, it must operate a Pay as You Earn (PAYE) scheme and contribute to employee National Insurance.

Get small business insurance with Protectivity

In order to protect yourself and your business, it’s essential to take out the right insurance.

Protectivity’s small business insurance includes public liability up to the value of £5 million, employers’ liability for those who have a team, products liability and optional commercial legal protection.

Find out more and get an online quote tailored to your needs.