No matter you’re a one-man-band or have employees lending you a helping hand, every size of business requires the right legal structure to operate effectively.
In the end, the legal structure you choose to go with will impact everything from the tax you’ll pay to your take-home profit and wage.
Sole trader and limited company are the most popular legal structures in the UK.
But working out what option is right for your business can be a daunting task.
To decide on the route that’s the best fit for your business, let’s explore the ins and outs of both the business structures.
What is a Sole Trader?
A sole trader is normally a self-employed person who is the only owner of their business.
This clearly means that there is no legal separation between you as the business owner and the business itself.
Being a sole trader, you can keep all the profits you’ve made after-tax and are responsible for any losses your business makes.
What is a Limited Company?
In a limited company, the liability of shareholders is limited to what they invested or guaranteed to the company. Hence the word “Limited” is used.
A limited company is a legal entity and can have one or more directors and shareholders.
By setting up a limited company, you can serve your business as its director.
As a director, you’re responsible for the financial and legal decisions your business makes, but your business’s liabilities and assets are totally separate from your personal finances.
This means that all profits and losses strictly belong to the company, meaning you must always act on behalf of the company.
If you are a freelancer or contractor and decide to have a limited company, you also need to have knowledge of IR35 legislation.
How to set up as a sole trader?
Setting up as a sole trader is simple; this is likely why it is the most popular business structure.
To be a sole trader to have a National Insurance number & inform HMRC by registering for self-assessment if you have earned more than £1,000 in a tax year. i.e. from 6 April to the 5 April of the following year.
While naming your business, you’ll have option either trade under your own name or a business name.
Keep in mind that when it comes to naming your sole trader business, other business can trade under the same name as both are entirely within their rights to do that.
So, choose the name carefully, especially as an error in judgment could result in your business being mistaken with a low reputation or service.
How to set up a limited company?
To set up a limited company, the first thing you need to choose is if you want to be a Public Limited Company (PLC) or Private Limited Company (LTD).
PLCs need to have a share capital of £50,000, a minimum of two shareholders, two directors and a qualified company secretary.
That’s why small businesses, contractors and freelancers tend to establish themselves as a private limited company.
Now, you need to select your company name; your company name needs to be unique – unlike setting up as a sole trader business.
By registering your company name with company house, you’ll also register your business for corporation tax.
Following registration, you’ll get a certificate of incorporation, which will detail the date of formation, company number as well as proof that your company legally exists.
So, let’s take a closer look at the advantages and disadvantages of both the business structure starting with the sole trader.
Easy to set up
Setting up as a sole trader is easy and relatively little paperwork required, other than an annual self-assessment tax returns.
Sole traders can get greater privacy than incorporated businesses, whose details are on public domain and can be found via Companies House.
Sole-traders are fully liable for any loss their business makes, so they may have to use their own money to repay any debts.
There’s no one to share accountability being a sole trader. Whilst you can hire staff, any critical business decisions fall to only you.
Sole traders can be less tax efficient
Tax rates on sole traders are not always as kind as on limited companies. When you reach a certain amount of earnings, it might not be quite as profitable to stay a sole trader.
If you are a freelancer sole trader and need to save more tax, then our guide Tips for Freelancers to Save Tax in the UK will help you.
Now, let’s see what advantages and disadvantages does setting up a limited company brings?
Advantages of a limited company
Limited liability protection
Unlike a sole trader, a limited company owner has the benefit of limited liability, as incorporation forms a legal distinction between the owner and their business.
This means that personal assets are not exposed – you only stand to lose what you put into the company.
Besides, limited companies will be more tax-efficient than sole traders, as rather than paying Income Tax limited companies to pay corporation tax on the profits.
As things stand, this offers a kinder tax rate, meaning forming a limited company can be more profitable.
You could claim more tax relief
There’s a broader range of relief and tax-deductible costs that a limited company can claim against its profits.
Setting up a limited company can be quite confusing and complex for new business owners because it has a more complex business structure compared to sole traders.
More complexity of a limited company generates more accountancy and administration procedures.
However, this is when a specialist accountant can help. To make the procedure of choosing an accountant simple, read our blog When to Hire an Accountant – A Small Business Guide.
Lack of privacy
Any data submitted by the limited company to the Companies House, like accounts, name of directors are on the public domain and accessible freely.
To let you see what to expect with each one legal structure at a glance, we have created below table,
|Sole Trader||Limited Company|
|Be your own boss||yes||yes|
|Easy and quick set up process||yes||yes|
|Work with a verity of clients||yes||yes|
|Incorporate a company||No||yes|
|Pay yourself a combination of dividends & salary||No||yes|
|Pay corporation tax||No||yes|
|The benefit of limited liability||No||yes|
|Work with the majority of recruitment agencies to source assignments||No||yes|
Ultimately then, it’s vital to weigh up the difference between a sole trader and limited company, as which structure you choose could impact on everything from profits to paperwork. Don’t rush into any decision and before finalizing anything speak to an accountant if you’re unsure, as their expertise can be valuable when it comes to the tax facts.