Sole Trader vs Limited Company: Which is the Best Option for Tax?

Whether you're a seasoned business owner or just starting your entrepreneurial journey, our team break down the advantages and considerations here for both Sole Trader and Limited Company structures to help you make an informed decision about the optimal tax approach for your business.

Sole Traders

What is a Sole Trader?

As a sole trader, you own the entirety of your business and as a result, are completely responsible for all decisions, and therefore any of its successes and failures.

You are tied to your business legally as one entity, rather than separate from it. This can have its benefits and drawbacks as you are entitled to keeping all of the profits, however, you are also responsible for any debts the business falls into.

Tax Implications for Sole Traders

There are very few tax obligations and regulations to follow as a sole trader, as you are also classed as self-employed. All sole traders have to do is submit an accurate Self-Assessment to HMRC once a year to be compliant. 

Sole traders can also benefit from having more tax relief available to them. For example, a sole trader may be eligible for the trading allowance tax exemption, which allows you to claim up to £1000 per year as self-employed income. This is generally utilised by sole traders who earn up to £1000 per year from their business.

SOLE TRADER ACCOUNTING SERVICES

Advantages of Being a Sole Trader

• Quicker and easier setup process with fewer ongoing administrative tasks. Sole traders don’t have to register with Companies House when setting up and there is little to no paperwork required to be submitted, besides your annual Self-Assessment.
• Fewer tax obligations. Sole traders do not have to pay Corporation tax and all sole traders have to do is submit a Self-Assessment tax return to HMRC at the end of each tax year. Despite having fewer obligations, you are completely responsible for your paperwork being accurate to avoid penalties or fines, so it can be best to work with a professional accountant.
• Complete ownership of all the company’s profits after tax. In conjunction with this, you also have complete control over the business decisions without needing to consult with any business partners, shareholders or external influences. 
• Private financial information. Unlike limited companies which have all their information publicly accessible on Companies House, sole traders don’t have to disclose any financial information publicly. 

 

Disadvantages of Being a Sole Trader

• Less tax efficient. Sole traders pay 20-45% income tax compared to limited companies, which only pay 19% Corporation tax. Sole traders are taxed on all profits or losses personally, whether you withdraw from the business or not. Many companies, therefore, make the move to become limited companies once they generate enough profit to stop needing to withdraw to prevent these from being taxed. Sole traders also aren’t able to pay themselves dividends as owners of a limited company, which benefits from a much lower tax rate. 
• Complete liability. Sole traders are 100% responsible for the business’s finances and therefore any losses or debts that need repaying which can lead to your personal assets being vulnerable. Sole traders are also unable to share the accountability of any business decisions made as they all fall down to you solely. 
• Less funding opportunities. Banks and investment companies generally favour limited companies due to the legal protection this provides and their credit scores, making it more difficult for sole traders to receive funding and grow. When trying to borrow money, your personal credit rating will be used by banks which can be limiting.
• Less credible. Due to the lack of legal protection sole traders provide clients, they are generally seen as less credible when compared to limited companies. 
• Business names of sole traders are unprotected. Unlike limited companies, anyone can trade under your name legally as it is not legally protected. 

 

Limited Companies

What is a Limited Company?

A limited company is a business that is a legally separate entity from the owners, directors, and shareholders, and can have multiple proprietors. 

The risk and liability of the company are reduced as the company is legally separated from whoever owns it no matter how many people own or manage the business.

Tax Implications for Limited Companies

Limited company owners or shareholders benefit from the ability to be able to pay themselves through a combination of salary and dividends, which if handled effectively can lead to increased tax efficiency as a business overall. For example, many choose to pay themselves with a small salary that is lower than the tax and National Insurance threshold, with a dividend to top this up as dividends are not subject to National Insurance and are taxed at a much lower rate than Income tax. 

Limited companies have a more comprehensive range of tax obligations than sole traders. You must submit a Company Tax Return, submit your accounts to Companies House, and each shareholder must submit a personal tax return Self-Assessment for any personal income taken in the form of dividends. 

LIMITED COMPANY ACCOUNTING SERVICES

Advantages of Being a Limited Company

• Salary and dividends. Limited companies can pay owners and shareholders a salary and dividends which have a lower tax threshold than a salary. Limited Companies also only pay 19% Corporation tax on any profits, and qualify for more allowances and tax-deductible expenses for better tax efficiency. 
• Limited liability. Owners and any shareholders don’t have liability, whereby if the business makes any losses or falls into debt this is no one’s personal liability or responsibility as the company is legally a separate entity to them.
• Easier process to leave the business. Compared to other business structures, it is fairly simple to leave a company or sell shares in a limited company. 
• Increased funding opportunities. Lenders and investors favour limited companies due to their legal protection and tax advantages for them. 
• Increased credibility. Limited companies benefit from credibility among clients and suppliers as many prefer to work with limited companies over sole traders due to legal protection. 

 

Disadvantages of Being a Limited Company

• Increased tax and administrative obligations. Compared to being a sole trader, there are increased obligations for tax and admin, whereby you must file annual accounts and a Confirmation Statement to Companies House and HMRC, as well as follow PAYE procedures.
• More complex and costly to set up. The initial setup process is more lengthy and costly for limited companies, as you must register your business with Companies House and incorporate your company.
• Less privacy. Limited companies are less private by nature as your business’ finances are accessible publicly on Companies House once you are registered. 
• Less decision-making flexibility. Unlike sole traders, there are usually multiple people involved to consult before actions can be taken.

 

What is the Difference Between a Sole Trader and a Limited Company?

SOLE TRADERS	LIMITED COMPANIES
Self-employed, single owner and legal entity - a sole trader is legally tied to their company along with all their personal assets	Can have multiple owners and shareholders
Completely responsible for business decisions and liability, meaning you have full control	The company is a legally separate entity from the owners and shareholders, meaning they are not tied or responsible for liability
The owner can keep all profits after tax, however, tax is not paid at a flat rate	Profits are taxed with Corporation tax, Income tax and National Insurance
You don’t have to incorporate or register your company as a business	Must pay Corporation tax and incorporate and register your company as a business with Companies House

 

Can You Change from a Sole Trader to a Limited Company?

Yes, you can change your business structure from a sole trader to a limited company at any point, although there is a process involved in doing so that you must follow.  

Many business owners decide to do this for the following reasons:

• Profits have increased to a level where the business can function more tax efficiently
• To improve credibility and attractiveness among potential investors, clients and suppliers
• To access more business funding opportunities

 

Questions to Ask Yourself When Choosing a Tax Structure for Your Business

• Tax efficiency - which business model is most tax efficient? What are your expected profit figures?
• Tax obligations  - what are the tax obligations and responsibilities you will need to follow?
• The legal relationship between you and your business - what is the legal distinction between you and your business?
• Liability and risk - what are you liable for financially? Is your business considered high-risk?
• Pay - how can you pay yourself? Will this be your sole income source?
• Privacy - how private is your business’s financial situation?
• Administrative responsibilities - what are the setup processes and ongoing admin tasks involved in the different business models?

 

Work with Chartered Online Accountants

Navigating the complexities of tax structures and ensuring compliance with regulations can be a daunting task for any business owner. At Pineapple Accounts, we understand the importance of expert advice and tailored solutions when it comes to optimising your tax position. 

Our team of dedicated chartered online accountants is highly experienced in offering our services to both sole traders and limited company structures. We can also assist you in making the right decision based on your unique business needs and goals if you are unsure of the best structure for your business.

Our comprehensive range of services includes tax returns, VAT, bookkeeping, financial reporting, payroll, and more. We'll work closely with you to maximise your business’ tax efficiency and ensure compliance with all relevant tax laws.

You can use our free quote calculator to identify the best monthly accounting package for you or contact us via WhatsApp to speak to one of our chartered online accountants for more information.