Limited Company or Sole Trader?

While many small businesses are struggling during the Covid-19 pandemic, it seems likely that, once it’s all over, there could well be a rise in the number of businesses being launched. For some people, particularly those who have been furloughed, it has given them some precious time to think about that business idea that’s been in the back of their mind for a while.

Also, the marketplace has changed and while some businesses are suffering, new opportunities have emerged. For instance, there’s an appetite for people turning to home deliveries and this could well continue, particularly as some folk will continue to work from home for the foreseeable future.

With a business idea bubbling away, one of the first questions somebody needs to address is whether to be a sole trader or establish a limited company. This is important, as you need the correct legal structure to operate effectively and it can affect the level of tax you’ll pay and what you can pay yourself.

Often people will decide on one rather than the other fairly quickly, but then they’ll have a chat with a friend or neighbour, who will come up with a raft of ideas as to why one is better than the other.

Here we look at the key differences:

Sole trader
According to figures from the Department for Business, Innovation & Skills, in 2019, the UK private sector business population was made up of 3.5 million sole proprietorships (or traders), accounting for 59% of the total. As a sole trader, you are basically a self-employed person who owns their own business.

Legally, there is no separation between the owner of the business and the business itself. As the business owner, you keep the profits (after tax) but you are personally responsible for any losses the business makes, leaving your own assets at risk if things go wrong.

It is a fairly simply process to set up as a sole trader – all you need is a National Insurance number and to register with HMRC. There is no requirement to have a name for your business, although most people decide to have one.

As a sole trader, you will pay tax on your business profits, after submitting a self-assessment tax return. While most sole traders keep a track of their income and expenses, they are not legally required to complete and file annual accounts.

Limited Company
In 2019, there were around two million limited companies. If you decide to set up a limited company, you will be a director of the business (which could be just yourself, or you might have employees).

As a director, you’re legally responsible for the decisions the business makes, but the business’ assets and liabilities are separate from your individual finances. Profits and losses thus belong to the company and you act not for yourself but on behalf of the company.

Setting up a limited company is more complicated than becoming a sole trader. You need to be at least 16 years old and not be prohibited by a court order from being a company director and have no history of bankruptcy.

As a limited company, you will need a company name and this needs to be unique. This will need to be registered with Companies House, after which is will be protected by law. You will also be liable for Corporation Tax.

Tax and National Insurance will be deducted from directors’ salaries via PAYE and, as a director, you will be expected to complete your own tax return.

You will need to prepare annual accounts for the company, which are filed with HMRC as part of the company tax return, as well as being sent to Companies House (and shareholders, if you have any).

In addition to the practical and legal differences between a sole trader and a limited company, there is the question of credibility. Some associates and suppliers, for instance, won’t be concerned about the legal entity of your business, while others will look at a limited company as giving the impression of a more established organisation, suggesting credibility. In some sectors, it might be that certain agencies might not work with sole traders because of the legal protection a limited company provides.

At Lewis & Co we work with both sole traders and limited companies and would encourage you to get in touch with us while you are setting up your new business to chat through which entity would work best for your particular circumstances. Call us on 01892 513515.