Limited Company or Sole Trader?

Should I be a sole trader or set up a limited company?A question that often arises when someone decides to become self-employed is whether to set yourself up and trade as a limited company or as an individual (a sole trader or partnership for example).

There are advantages and benefits to each depending on your situation which will have implications in relation to tax, the law, legal and financial responsibilities, and documentation and paperwork. There is no simple answer, since everyone’s situation is different.

Making the wrong choice could result in you paying more tax than you need to, which of course is something that we all want to avoid!

Part of the decision comes down to the kind of work you’ll be doing or services you’ll be providing, and the kind of clients that you will be working for.

If for example you’re going to be designing electronic circuit boards for appliance manufacturers then they would be far more likely to want to deal with a limited company than a sole trader. It might just be psychological, but it will impact on the amount of work that you can attract, so it is something that must be considered.

The disadvantages of a limited company are that you have more rules and regulations to abide by, your accountancy costs will be higher, and there are specific rules for the paperwork and submission of accounts and documents.

In terms of actually paying yourself you have to record money you take from the business as a salary or dividend (or loan in some circumstances), and you will be liable to pay corporation tax (currently at 20%).

However, what many owners of limited companies do is to pay themselves a salary that is little over the threshold where you are liable to pay income tax and national insurance, so you are paying a minimal amount of tax and NI, then set aside the 20% to pay in tax later, and pay themselves the remainder of their income as a dividend.

This is done because once the corporation tax has been paid there is no taxation liable on dividends, and so the amount of tax and national insurance that you pay can be minimised and kept far lower than paying yourself all of your income as a salary.

On top of this benefit is the additional protection of your personal assets since the limited company is a separate legal entity to you, so even if the company goes bust your house and savings, etc will be safe from creditors.

Alternatively if the limited company approach isn’t right for you, then setting yourself up as the business (i.e. becoming a sole trader) is far easier.

First of all you need to create a legal structure formally and let the authorities know how you are trading. To do this you simply contact HMRC and register for self assessment.

Limited Company vs Sole Trader

The benefits and drawbacks of each are summarised below:

Sole Trader:

You are the business & owner.

Sole traders and partnerships are not required by law to have or file annual accounts, but annual accounts are needed for Inland Revenue tax returns.

Sole traders and partners can borrow as much as they like, there are no restrictions.

Tax is usually paid in instalments on the 31 January in the tax year and the 31 July following the tax year.

Losses can be offset against other income for the current year, or carried back to prior years.

Profits are taxed at 40% on taxable income in excess of £32,010 and at 45% over £150,000 (2013/14).

Required to pay class 2 NI payments of £2.70p.w. plus Class 4 NI depending on profits.

Limited Company:

The business is a separate legal entity.

Companies must comply with The Companies Act. A company must:

• Keep accounting records;
• File accounts and an Annual Return with the Registrar of Companies, which is publicly available;
• Keep Statutory Books;

Companies could have greater borrowing potential by using current assets as security.

Tax is due on director’s remuneration paid via PAYE, and if applicable higher rate tax is paid by shareholders on dividends under self-assessment rules.

Losses can only be carried forward to offset against future profits.

Corporation tax is 20% for profits up to £300,000.

There is both employers and employees national insurance due on directors salaries and bonuses, which is higher than for a sole trader or partner.

There are of course many other things to consider such as legal requirements, employment law, pensions, etc, etc, etc, so it is always best to get independent professional advice before making your final decision.