We often have people ask us whether they should register as a sole trader or a limited company. We know how confusing the options are and how important making this decision is. Don’t fret – you’ve come to the right place. This guide outlines the difference between being a sole trader and a limited company and why you might choose what is right for your business.

What is a sole trader?

According to HMRC “if you’re a sole trader, you run your own business as an individual and are self-employed.”

What is a limited company?

HMRC explains this as “a limited company is a company ‘limited by shares’ or ‘limited by guarantee’ “. In a nutshell, limited companies have their own legal identity, separate from their owners (shareholders) and managers (directors). This applies even if a limited company is run by one person.

If so far it feels like we’re talking another language, don’t worry. Keep reading as it will start to make more sense as we go through the pros and cons of each.

Advantages of being a sole trader

  • You can get started as soon as you want to as there’s no requirement to register with Companies House. You will need to register for Self-Assessment by 5th October after the end of the tax year that you started your business.
  • You only need to submit an annual self-assessment tax return and you don’t need to pay Corporation Tax or file company accounts to the Government. There are also minimal record-keeping requirements.   
  • You are the only one in the business so you can make all the decisions without needing to consult shareholders or partners. 
  • You run your business as an individual and retain all the profits that you make after you’ve paid tax. 
  • Your financial information remains private, unlike that of limited companies which is accessible by anyone via Companies House. 

Disadvantages of being a sole trader

  • You take on all the risks associated with running a business and you hold all the responsibility for its debts. You could find yourself in a situation where you need to sell off personal assets such as your house to pay those debts off. 
  • Raising business finance can be difficult as lenders and investors tend to favour limited companies. This means the growth of your business could be slower than if you were running a limited company. 
  • Sole traders pay 20-45% income tax, compared to limited company owners who pay 19% corporation tax. Sole traders are taxed on the profits or losses of the sole trade personally, regardless of what profits they physically withdraw from their business bank account. Consequently, when the business is doing well, and you can afford to leave some of the profits in the business, it may be time for you to form a limited company. 
  • Some organisations choose to not work with sole traders due to the lack of legal protection compared to limited companies.
  • Unlike limited companies, your business name is not protected. This means anyone can trade under the same name as you which could cause confusion. 

Advantages of being a limited company 

  • A limited company is legally separate from shareholders and directors so you are not personally liable for any losses made by the business.
  • Running your business as a limited company provides the potential for more profitability. Unlike sole traders who pay 20%-45% income tax, limited companies pay 19% corporation tax so they tend to be more tax efficient. They also qualify for a wider range of allowances and tax-deductible expenses. In addition, shareholders can withdraw dividends from a business which don’t attract National Insurance and have a lower income tax rate than a salary.
  • Being a limited company opens you up to more opportunities to access funding. Business finance lenders and investors tend to favour limited companies over sole traders due to the level of legal protection and tax benefits.  
  • Operating as a limited company can encourage more confidence and trust among suppliers and customers. Some businesses prefer to work with limited companies.  

Disadvantages of being a limited company

  • Being a limited company involves more paperwork and administration than operating as a sole trader. The actions you need to take include registering with and paying a fee to Companies House, filing annual accounts to Companies House, filing company accounts and tax returns to HM Revenue & Customs, and filing a Confirmation Statement to Companies House. All these complexities mean it is advisable to employ the services of an accountant.
  • Limited companies have less privacy than unincorporated businesses because the accounts and other documents they file with Companies House are on public record and can be accessed by anyone. 

There’s no right or wrong answer when it comes to deciding whether to register as a sole trader or a limited company. The decision is personal and you’ll know what’s right for you based on the advantages and disadvantages of each. There are no major requirements for either. To set up as a limited company all you need is a company name, registered office address, service address, one director and one member. If that all sounds overwhelming, we’d be happy to help. You can contact us here. We’re experienced accountants based in Bury St Edmunds who have helped countless businesses set up for the first time or make a switch.