Limited Company vs Sole Trader?
Deciding on the right structure if you are looking to start a business can be hard as there are lots of factors to consider. The sole trader option is typically for those who have less business operations to manage, and can be more flexible with less legal obligations, whereas limited companies are typically formed if the company has larger profits.
Limited company - A limited company is a business structure (legal entity) which is run by either one or multiple directors who are separate from the entity. A limited company will also have shareholders who invest in the business with a respective amount of shares issued to them
Sole trader - A sole trader, also known as being self-employed, is the simplest business structure. All business operations are ran through one person, where they make all decisions and all company profits are retained by them (subcontractors can be hired for specific work, but the business is still ran solely).
Key Features and the Differences Between a Limited Company and Sole Trader:
| Limited Company | Sole Trader | |
| Registering the business | Company owners/ directors will need to incorporate their company first before trading. You can set up a limited company through Companies House. | When self-employed, you can start trading before registering as a sole trader. However, registering for self assessment tax will be required once you pass the earnings threshold. |
| Legal risks and liability | Company owners are responsible for business debts, however this is only up to the value of their investment in the company (limited liability). As this is a limited entity, the company may give the director's protection. | As the sole runner of the business, you are responsible for all debts incurred. Since the entity is not 'limited' and therefore not as protected, business insurance may be required. |
| Retaining profits | The company itself retains the profits, but the directors are able to take money out of the business. This can be in the form of a salary or dividends. | The sole trader will retain all company profits. |
| Keeping records and accounts | You will need to keep and collate all company financial records for when it comes time to file annual accounts with Companies House and HMRC. | It is best to keep a record of all accounts when it comes to submit a self assessment form. |
| Employment status and taking on employees | Limited companies can have employees. Typically they will need to register with HMRC and set up a PAYE payroll for paying it's employees. | As a sole trader you will be classed as 'self-employed' and you will still be able to have employees. |
Sole Trader to Limited Company
If you are currently self-employed and it feels like the business is growing and becoming harder to manage alone, then there is the option of incorporation where you can form your own legal entity. The sole trader to limited company route is a common one for a lot of companies that are formed.
There are also reasons why you may want to move from being self-employed to becoming the sole director of a limited company, where having other directors or employees are not necessary for the business.
If you would like to read more on moving from sole trader to limited company, please feel free to read our related article on this here.
Filing Expectations for Entities:
Sole Traders
For sole traders, filing requirements are typically a lot simpler. Since being self employed is not a legal registered entity, you would not be expected to file anything with Companies House, naturally.
Then depending on the amount of income that the business receives, HMRC would expect you to file the following:
- If you receive over £1,000 in a tax year, then you must register with the self-assessment service which provides a Unique taxpayer Reference (UTR) number. Annually, you would be expected to file the Self-Assessment return (SA100) to HMRC.
- If the company makes a profit (and submitted via SA100) then you would be expected to pay income tax.
- If the business exceeds the current £90,000 turnover threshold, then you would need to register for VAT and typically would need to submit VAT returns to HMRC quarterly.
- If you employee people you will also need to register for PAYE
Limited Companies
The list of filing requirements for limited companies is typically longer. Since the entity is registered with Companies House, you would typically be expected to file the following:
- Abridged company accounts annually - this is a version of the accounts that contains only the Balance Sheet.
- Confirmation statement annually - a confirmation of company details each year.
Then for HMRC, typically you would be expected to file the following returns. The company must be registered for the corporation tax service in order to submit these filings:
- CT600 (Corporation Tax) return - this is a return that calculates the companies corporation tax liability (any amounts due to be paid) if any.
- Full company accounts (Profit & Loss statement and Balance Sheet)
- If the business exceeds the current £90,000 turnover threshold, then you would need to register for VAT and typically would need to submit VAT returns to HMRC quarterly.
- If you employee people you will also need to register for PAYE
So, Why Become a Sole Trader?
Becoming a sole trader only works for certain individuals looking to run a company, so it will depend on the type of operation you are looking to run.
The set up for self employment is fairly easy and you can begin trading right away, even before registering for self assessment. It requires a lot let legal and administrative requirements and fees than a limited company would do. Additionally, as a self employed person, you are able to keep your details private (place of work etc.) as it is not legally required.
Considering a Limited Company Instead?
Becoming a limited company may be more beneficial for your business in the long run. Running the operation as a sole trader may not be as tax efficient if you are making higher turnover. Running a limited company comes with protection, for example protection of assets from business debts.
It's important to consider all the factors, pros and cons on setting up either before beginning the businesses operations or trading. If you are unsure it would be best to search for any tax or legal advisors who would understand what works best for you.
