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Sole trader or limited company? Here are your pros and cons

If you are having a hard time deciding whether to register as a sole trader or limited company, we have some advice on both the definition and the pros and cons of each choice.

Sharon Main, Valued accountants

We talk a lot with our clients about starting out with a clear vision, or goal for your business and how to tackle the importance of finding your own why as a business owner, which will keep you happy over the years your business will operate. There are several reasons for this; firstly, it helps you establish how to budget and later how to staff your new business, and secondly, it gives you the clarity you need to set up the base infrastructure of your business.

Infrastructure is crucial. It’s more than just creating systems and manuals of operation, it is also how you set up the financial and legal remits of your business with HMRC and other governing bodies.

This quick guide is designed to help you understand your choices of HMRC registration, looking at the advantages and disadvantages of registering as a sole trader or limited company.

What is the difference between a sole trader and a limited company set-up?

The most important difference between registering as a sole trader and a limited company is about ownership and liability.

Sole Traders
Sole traders own the entirety of their business and resume all legal liability for the business operations, products and services. It is the simplest form of trading recognition here in the UK, but it does mean that lawfully you and your business are regarded as one entity. If you incur debts or have legal disputes with clients, or suppliers you are held responsible in the eye of the law.

You can register with HMRC here and should do so on the day you start to operate in sales or purchasing. Your last day of trading is not your last day of accounting, as you will need to file a year-end tax report for the given tax year you close out on by the required submission deadlines.

You will need to submit a self-assessment tax return annually, against your unique tax reference number (UTR), which can be the short form or long form process, based on your earnings. Your income and national insurance tax threshold is £12,570.

Sole trader VAT thresholds are £80,000 and you will also have to pay VAT on digital services (VAT Moss) at a threshold of £0.

As a sole trader, you get to keep 100% of your profits after tax.

A common misconception is that as a sole trader you cannot hire any staff. This isn’t the case, in fact, you can be a sole trader and employ as many freelancers (bear in mind IR35 rules), or in house staff as you need.

Limited Companies
A limited company by contrast is a business that is legally separated from a person’s identity. It can be run by one person, or a group of shareholders, splitting the ownership across equal shares. Limited companies carry their own liabilities, separate from shareholders and directors.

Typically most limited companies are run by a group of shareholders, rather than individuals, but there may be occasions, or even industries where having a separate legal identity may benefit individual owners. For example, limited company shareholders have a limited personal liability within the business, whether the arising situation is financial or legal.

You can register with HMRC here and should do so on the day you start to operate in sales or purchasing. You pay tax as a business and then individually as shareholders via self-assessment. Your personal shareholder income and national insurance tax threshold is also £12,570, just as it is for sole traders. VAT and VAT Moss also apply as they do for sole traders.

Staffing in limited companies is more common, as well as service provision by freelancers or contractors (for this you will need to abide by IR35 rules). This will add complexities of employment law and taxation. Here is a guide from HMRC on that.

Sharon Main, Valued Accountants

Sole trader pros and cons

Pros

  • Easy to set up
  • Little paperwork is required for registering with HMRC and all you require in return is your UTR and an understanding of your tax dates.
  • You are not required to submit your business to Companies House which allows for greater privacy
  • You are not required to submit your taxes via the Making Tax Digital process unless you are VAT registered (this is changing in the next few years, read more here)
  • You receive 100% of the profits are tax
  • You can also draw the previous year's losses against your current tax return figures, which lowers taxation
  • You make all of the decisions in your business
Cons
  • Unlimited liability which means that if you fall behind on debt payments, or have a large legal bill to pay that is not covered by insurance, your personal assets could be ceased as remittances
  • You take full responsibility for your business and wear all of the traditional business hats. This may mean longer hours, as well as learning new skills to get started.
  • You are responsible for staffing your business, which can sometimes be a headache to deal with
  • The will be limitations on your ability to raise capital via banks and financial operators, as these will be based on your ability to pay back loans and interest
  • The capacity to scale comes with investment in most cases and if a sole tradership receives limited funding, there implies a limited means to expand.

Limited company pros and cons

Pros

  • Each shareholder can pay themselves in a combination of pay and share dividends, the latter having lower taxation, starting at 8.75%. This allows the business to be more tax-efficient and profitable on higher earnings.
  • Limited companies are open to a wider range of tax allowances and deductibles. Here are your 22/23 tax cards.
  • Shareholders can leave the business much more quickly and cleanly, by transferring shares. Shareholder agreements are redrawn and stamp duty is paid on stocks by the shareholder leaving the business.
  • Personal assets and your identity are protected in legal or financial loss or debt scenarios, as each shareholder takes liability for the business debts and the limited company business is effectively sued, not the individual.
  • There is a level of credibility in certain circles for limited companies, which can open doors, negotiations and help you win quotes
  • Once you have registered your business name with Companies House no one else can use it
Cons
  • Fees apply to setting up a limited company, paid directly to Companies House.
  • Your annual accounting needs to be more detailed and submitted to HMRC via the Making Tax Digital Scheme. This also includes the submission of an annual corporation tax return and a confirmation statement, as well as quarterly VAT submissions, when you reach the £80,000 threshold or £0 for VAT Moss.
  • Each director is then required to file a self-assessment tax return on his/her/their earnings from that business
  • Annual accounts have to be submitted to HMRC for tax filing and Companies House for public record, which means less privacy, as details of ownership and registered addresses, can be found via Companies House public records.
  • Shareholders cannot draw money from the business freely, instead, extended pay comes from shareholder dividends at the end of a good year or increased annual salary, or shareholding.
  • The losses of the business cannot be used against personal shareholder tax returns
  • Shareholders have a director’s fiduciary responsibilities, which outline what a limited company director must do legally to ensure good faith and loyalty to the business, its shareholders and employees.
  • Business decisions are based on shareholder agreements and votes

Which should I choose: sole trader or limited company?

Based on the information we have provided above you may feel that your choice is simple and it might be. If we could advise on caution here, we would ask you to take some time to think about how your business might play out long term. What scale and complexities are you imagining? How much help would you need to achieve what you have your goal sights set on? Then consider the benefits of each proposition based on what you’d like your business to become, does one option reap more rewards than the other?

A good accountant can help with your financial paperwork, as well as some of the initial HMRC setup and annual filing. So please don’t think that if you have a lack of dictatorship experience that a limited company set-up might not be for you.

If this feels like an incredibly hard decision to make, or it is something you’d like to seek more advice on, then contact our team of accounting specialists and we can talk you through the processes of set-up and filing through us for each route.

We are here to support you regardless of your choice. We manage tax filing for both company and individual tax year-ends; documenting your business assets, share capital and dividends, and paying VAT, as well as personal tax and national insurance. 

We are much more than that, we also provide you with your own accounts manager who can advise you on your financial journey as a business owner (or business owners), helping you concentrate on what you do best, whilst understanding how to financially achieve it.