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Sole Trader or Limited Company Dilemma

Should you be a Sole Trader or start a Limited Company?

One of the first major decisions a start-up business will come across is the decision to trade as a Sole Trader or a Limited Company. There are pros and cons both that this article will focus on. Hopefully this article will help you to decide if you should stay trading as self-employed or a Limited Company.

What are the Advantages of being a Sole Trader as opposed to a Limited Company?

The main advantage of trading as Sole Trader is there are no costs associated with forming the company or fees to keep the company in good standing (filing of annual returns, book-keeping and accountancy costs to prepare and file the financial statements).

One of the other advantages of trading as Sole Trader is that there is no requirement to make your information public, as it is for the Directors/Secretaries and Shareholders of a Limited Company. There are ways of overcoming this when forming a Limited Company, for example, using another address as a registered office address or officer Service address, to keep your residential address off the public records. Should you wish we can provide these services to help you to preserve your confidentiality.

A Sole Trader compared to a Limited Company does not pay have to pay Corporation Tax before they can withdraw the money made from trading activities.

For some business people trading as a Sole Trader this arrangement gives more freedom on how they run the business without the restrictions imposed by the Companies Act on Limited companies owners and directors.

Also worth noting that losses made by a Sole Trader can be set against other income of the year or carried back to proper years, which is not the case with a Limited Company (losses are only allowed to be carried forward and be off-set against future gains).

What are the Disadvantages of a Sole Trader vs Limited Company

The main disadvantage of a Sole Trader compared to a Limited Company is that there is no legal distinction between the business and the owner, which means that the individual is at risk of losing his/her assets, if the business fails.

Trading as a Sole Trader carries less prestige and many suppliers/customers prefer to deal with a Limited Company.

It is more difficult to sell a Sole Trader business. It is also much harder to raise funds.

Company formation (either Limited Company or Limited liability partnership) seems like a natural progression from Sole Trader.

The main comparison features of Sole Trader vs Limited Company can be summarised as follows:

Features Sole Trader (Self-Employed) Limited Company
Set Up Costs
  • No Ltd Company Formation Costs
  • A company must be formed with a Memorandum and Articles of Incorporation (written constitution)
Capital Requirements
  • Shares do not exist
  • No minimum capital is requirement
  • Minimum capital requirement of GBP1 (although not recommended as it does not convey the assurance to the customers/suppliers)
  • Sole Trader pleases himself in this matter, duties are not formal
  • A Company Director/Secretary is responsible to comply with the statutory regulations set up in the Companies Act 2006. The duties of the Company Director are clearly defined and formal
Employment Status
  • Self-employed
  • For Income Tax purposes and National Insurance a Director is treated as an employee
Extraction of profits
  • Sole Trader (Self-Employed) pays Class 2 & 4 National Insurance and Income tax on the taxable profits
  • Earnings may be withdrawn through dividends and salary
  • Sole Trader is personally liable for all his business debts. There is no distinction between personal and business money
  • The Ltd Company is a separate body from the owners/shareholders and hence no personal liability and your liability is limited by the amount unpaid on your shares. The Directors of Ltd company only liable if they continue trading when ltd company is insolvent

Sole Trader (Self-Employed) accounts are basic, they list income and expenditure and an accountant is not always required saving a significant cost.

Information is not available to public

  • Director/Shareholder information is available to public at Registry
  • An annual return and accounts required to be submitted along with other returns
  • Abbreviated accounts required for small companies, which moist likely require the help of accountant, hence increase the cost.
Records No requirement
  • Records and minutes of meetings must be maintained
Withdrawal of profits Sole Trader my withdraw cash from business without tax
  • Ltd company is regulated by the rules for capital maintenance restrict shareholders from extracting profits if accumulated profits are insufficient

Sole Trader or Limited Company — Taxation considerations

Taxation is an important, although not the only consideration, when looking on how to trade as a Limited Company or Sole Trader (same as self-employed or Limited Company). The below tax calculation illustrates how a Limited Company can still result in a lower overall tax cost compared to a Sole Trader (based on UK tax rates and thresholds for 2012/13).

Tax Type Annual Profits
£10,000 £50,000 £100,000 £200,000
Sole Trader
National Insurance (Class 2 & 4) £354 £3,427 £4,427 £6,427
Income Tax
20% £379 £6,874 £6,874 £6,874
40%/50% 0 £3,010 £3,010 £71,252
Total £733 £13,311 £34,311 £84,553
Limited Company
Corporation Tax (@20%) £503 £8,503 £18,503 £38,503
Income Tax
40%/50% 0 £568 £10,568 £36,812
Total £503 £9,071 £29,071 £75,315
Potential Tax Saving if trading through a Limited Company versus Sole Trader £230 £4,240 £5,240 £9,238

The above calculations are based on assumption that profits are extracted by through salary (equal to personal allowance), the reminder through dividends. It was also assumed that the owner does not have other taxable income.

If you require help to decide to choose between Sole Trader or a Limited Company structure for your particular circumstances, it is best to seek the advice of accountants. The above comparison table Sole Trader vs Limited Company does not constitute any advice and is for illustration purposes only.

Sole Trader or Limited Company — Other commercial considerations

Trading through a Limited Company undoubtedly adds to your image and credibility in the marketplace and in many instances helps with getting a credit from a new supplier or even to be included on the approved list of suppliers of large companies.

A Sole Trader relies on their own personal credit rating to borrow, whilst a Limited Company can establish its own and borrow money in its own right.

Self Employed or Limited Company — what is right for you?

There are many factors needing to be considered what is best for you to be Self Employed or a Limited Company. To answer this question there are many different considerations but the main one is the tax saving that can be made by trading through a Limited Company. The savings depends upon individual circumstances but are made on tax and national insurance.

In the recent years many large companies preferred to use consultants who are trading as a Limited Company as opposed to a Sole Trader.

Self-employed consultants (contractors) prefer to trade as a Limited Company instead of a sole trader as it gives benefits to both employer and the consultant. The employer does not make NIC or PAYE for the interim/temporary staff; the consultant controls the way he distributes profits and can utilise some tax saving offered when trading as a Limited Company versus sole trade, taking into account IR35 tax issues.

Irrespective of how you choose to trade – as a Limited Company or Sole Trader or limited liability partnership, you would need to inform HMRC about the commencement of the any trading activity.

Dormant Company

A dormant company is a normal limited company, the only difference is that it is not trading until you decide to use it. The main advantage of forming a dormant company is to prevent your company name being used by another Limited Company. It also guarantees that the name will be available when it makes economic sense to you.

Maintenance of non-trading (dormant) limited company is simple (we provide such a service at request) and is should be considered if you are not ready to trade as a Limited Company. Should you decide your ltd company would be dormant, you must not use its requisites on the invoices or other correspondence.

Starting a business as either a Sole Trader or a Limited Company is a big step for everyone, especially if it is your first time.

The decision depends on your individual circumstances, however we hope this short guide provides information to help you understand the differences better.

We are here to assist you, if you decided to incorporate a Limited Company.

by Elena Genovese