Sole Trader vs Limited Company: A Comparison

Pros

• Simple and inexpensive to set up and run
• Minimal administration and paperwork
• You keep 100% of the profits
• Complete control over business decisions
• No need to file annual accounts or tax returns (just self-assessment)

Cons

• Unlimited personal liability for business debts
• Less flexibility for tax planning - you're taxed on profits whether drawn out or not!
• Less credibility with clients and investors
• Harder to raise capital
• May miss out on certain tax-saving opportunities available to limited companies

Pros

• Limited liability – your personal assets are protected
• Possibility to pay less tax particular if you don't need to draw out all profits
• More professional image and greater credibility
• Ability to raise capital by issuing shares
• More tax-efficient options for pension contributions and maybe financing of a "company" car

Cons

• More complex and expensive to set up and maintain
• Must file annual accounts at Companies House and submit a corporation tax return
• Profits are taxed at a corporation tax rate, and any dividends drawn also incur personal tax
• Increased administrative burden (e.g., board meetings, reporting to Companies House)
• Directors and shareholders have legal obligations to comply with company laws

 

Involvement of Family Members

• Whether sole trader or partnership, if a family member does work for your business you can formally employ them and pay them a wage for the work they do
• If a Limited Company, you could appoint them as a co-director with you, and/or they could be allocated some shares in the company and you could then pay them a dividend out of profits
• A partnership is also an option which avoids the administrative and bureacratic burdens of a limited company but gives you the opportunity and flexibility to share/spread profits over two or more people.
• The downside of a partnership is that, like a sole trader, all partners may become personally liable for debts of the partnership, each partner having joint and several liability. 

 

Taxation

For the past 2 or 3 decades, a general rule of thumb is that a business owner would save tax by trading as a limited company.  This was the result of various changes to the tax system in the late 1990s and early 2000s. 

 

Over the past decade or so, there have been various changes to tax and national insurance rules which has recently turned the tide and now, at most profit points for small businesses, the total tax and NIC paid is actually less by operating as a sole trader or partnership and more by trading as a limited company. 

 

The exception to this is a kind of "sweet spot" of profits between around £50,000 to £70,000 p.a., depending on personal and other specific circumstances, so only if your profits are forecast to be around £60,000 p.a. would a limited company save you tax (assuming a single person business with no family involvement and plan to withdraw all profits after tax).  

 

Of course, that's a very rough rule of thumb and other matters also need to be considered, such as:-

• Company taxation will be lower if you don't need to withdraw all after-tax profits as you won't be paying personal dividend tax on profits you've not drawn.  However this is more of a "deferment" as ultimately there will be tax when you draw out the profits at a later date.
• There are very different rules re company vehicles so various matters will affect the tax relief on a business purchase of a car or van such as:-
  • Whether it's a car of van (as per HMRC definitions);
  • Business mileage compared with private/total mileage;
  • Whether you intend to buy or lease the car;
  • List price of car when new;
  • CO2 emissions;
  • Type of vehicle, i.e. petrol, diesel, electric or hybrid.
• Use of home as office claims, whether you're happy to claim a nominal amount per HMRC official rates or whether you wish to claim a higher proportion of your home based on time and floor space occupied for business purposes.
• Whether you intend to make contributions to a personal pension scheme out of the business profits.
• As mentioned above, whether you have a spouse, civil partner or other household members who work for the business and can therefore be paid wages, profit shares, and/or dividends.