Sole Trader Vs. Limited Company

What are the differences between a Limited Company (LTD) and a Sole Trader?

As a sole trader, you are personally liable for all your business’ debts, whereas, in LTD(also see limited company accountants), your business is a separate legal entity. That means your financial assets are protected in most cases of financial difficulties. 

Let’s go through each structure and help you make an informed decision.

Quick Comparison Table

Factor	Sole Trader	Limited Company
Legal Status	The individual and business are the same entity.	The company is a separate legal entity.
Liability	The owner is personally liable for debts.	Limited liability protects personal assets.
Taxation	Income tax on profits, National Insurance (NI).	Corporation tax on profits; NI & PAYE for wages.
Control	Complete control by the owner.	Directors/shareholders have roles; shared control is possible.
Admin & Filing	Minimal reporting requirements.	Must file annual accounts with Companies House.
Business Image	Often seen as more minor or more personal.	Professional and larger company image.

Who is a Sole Trader?

An individual who operates their business independently without legal distinction between themselves and their enterprise – thus taking responsibility for any debts or legal obligations related to running it as part of personal responsibility.

What is a Limited Company?

A separate legal entity created from shareholders (shareholders) and directors that offers limited liability protection – personal assets will likely remain secure even in cases of financial strain on behalf of the business.

Advantages of Being a Sole Trader

• Establishing yourself as a sole trader requires minimal paperwork and upfront expenses; notify relevant tax authorities and obtain the necessary licences before the business opens.
• As the sole owner, you have complete authority over all business decisions, enabling a quick and flexible response to market shifts. 
• Profits after taxes belong solely to you – offering direct evidence that hard work pays off financially.
• Since sole traders do not require publishing accounts publicly, any financial data remains safe and private.

Disadvantages of Being a Sole Trader

• As a sole trader, you assume personal liability for all debts and obligations of your business if it runs into financial difficulty, potentially placing personal assets at stake if necessary.
• Sole traders pay income tax up to 45% plus NICs, while limited companies face corporation tax of 19–25%, depending on profits.
• Raising capital may prove more challenging for sole traders without issuing shares, potentially hindering expansion plans.
• Some clients and suppliers may perceive sole traders as less reliable than limited companies, potentially hindering any opportunities when doing business together.

Advantages of Operating as a Limited Company

• Operating under Limited Liability can protect shareholders from personal assets; liability is limited solely by what was invested.
• Limited companies typically pay lower corporate income tax rates than individuals, and dividends distributed may also incur less stringent taxes.
• LTD afford their owners several distinct advantages, including enhanced credibility with clients, suppliers, and investors; 
• Limited Company also has access to funds via shares issued for growth and expansion purposes and extraordinary staff hiring flexibility.
• A company does not depend on its current owners for survival; even when ownership shifts, operations continue unimpeded.

Disadvantages of a Limit Company

As with any business venture, starting and operating a limited company comes with additional responsibilities and costs, including registration with relevant authorities, annual reporting requirements, and meeting statutory obligations.

• Financial statements and specific personal data regarding directors can be publicly accessed, potentially jeopardising their privacy.
• While dividends may be tax-efficient for shareholders, they’re not tax-deductible expenses for the company, and shareholders may face additional liabilities on any dividends received.
• Directors have legal obligations and responsibilities, and noncompliance can result in penalties or disqualification from office.

Financial Liabilities 

What are Personal and business-level liability differences between a sole trader and a limited company?

Sole Trader

• Sole traders are held personally liable in litigation unless appropriate insurance is in place. 
• Such insurance usually covers product and service liability, employer liability, personal indemnity, etc.

Limited Company

Limited companies, as legal entities, are held liable in the event of litigation. In the UK, it is rare and challenging to directly suit LTD directors or officers except in certain qualifying cases. For example, directors and officers may be held responsible for:

• Director or officer-perpetrated fraud, including tax fraud
• Criminal activity, like corporate manslaughter
• Violations of health, safety, and environmental rules
• Deliberate concealment of offences committed by directors or officers

Taxation and Profit

How sole traders and limited companies differ in tax obligations and profit treatment.

Sole Trader

• Sole traders pay Class 2 and Class 4 National Insurance and income tax on all business profits.
• Partners pay the same, but only on their share of profits.

Limited Company

• LTDs pay corporate income tax on all taxable profits. Corporate income taxed is lower than the personal income tax paid by sole traders.
• Company officers and employees are subject to individual income tax, NICS, and PAYE.
• Income tax is assessed on dividends earned by shareholders.

Sale of the Business

Below are the variations of tax implications when you sell your business as a sole trader versus a limited company. 

Sole Trader

• If you sell to a private limited company to set up, you can claim BADR relief under certain conditions. 
• Any profits realised through the sale of the business or its assets are taxed under capital gains tax rules. 
• Disposal of business assets or a partial interest in the business may also be taxed as capital gains.

Limited Company

• The sale of an LTD or its assets results in Corporation tax on any profits and taxes on shareholders for any distributions or proceeds they might receive. 
• Tax rules sometimes make it more beneficial to sell the shares of an LTD rather than the business itself or its assets.
• Company shares can be given to others as gifts.
• A company director owning over 5% of an LTD may qualify for less costly capital gains tax on gains of up to £10 million.

Accounting

Here are the accounting requirements of a sole trader and limited companies under tax obligations. 

Sole Trader

• Sole traders are not required to prepare accounts for tax purposes. However, doing so may still be beneficial for tracking business finances, debt collection, profit and loss, etc.
• Keeping annual accounts, including a balance sheet, may be necessary for personal tax purposes.
• A basic accounting format is available for sole traders operating below the VAT threshold.
• Sole traders do not submit accounts to HMRC except in cases of official investigation.
• Generally Accepted Accounting Practices are used to figure taxable profit for the Assessment unless cash accounting is used.

Limited Company

• Under the Companies Act, LTDs must prepare annual accounts filed with Companies House.
• Full accounts for corporation tax must be prepared and submitted online to HMRC.
• All accounts must be prepared using accounting standards.

Control and Management

Comparison of the level of control sole traders and LTD directors have on their business. 

Sole Trader

• You have complete control over your business. 
• It is suited for those who prefer simplicity and direct management.
• As a sole trader, you can make decisions quickly and efficiently without formalities.

Limited Company

• Directors manage the company, and shareholders hold ownership. 
• If you are the only director and shareholder, you’ll have similar control to a sole trader. 
• Adding more directors or shareholders means shared responsibilities and decisions.

Administrative Responsibilities

An administrative load and responsibilities for each business structure. 

Sole Trader

• You require minimal paperwork, making it a simple structure to manage day-to-day. 
• Although you are not required to file annual accounts, it’s good practice to maintain them for tax purposes. However, a self-assessment tax return is a must here. 

Limited Company

• Requires annual financial accounts. 
• You deal with tax filings with HMRC and records submitted to Companies House. 
• It takes more work but offers greater transparency and may help establish business credibility.

Borrowing, Financing, and Pensions

How sole traders and LTDs handle borrowing, financial options, and pensions. 

Sole Trader

• Sole traders’ business bank accounts are their own; they can borrow from them.
• If withdrawals result in an account overdraft, tax relief relating to bank charges and interest are restricted on any amounts counted as part of the overdraft.
• Sole traders are only eligible for personal pensions.

Limited Company

Under the Companies Act 2006, company directors may borrow from LTDs. Tax liabilities are as follows:

• The company pays a 25% charge.
• If the director receives an interest-free loan, they will be assessed a tax charge.
• LTDs can offer more generous company pension schemes with more benefits and fewer limits.
• LTDs can hold company assets in a SIP, SAS, or other unapproved pension scheme.

Business Gains and Losses

How gains and losses affect tax for sole traders versus LTDs. 

Sole Trader

• You can use the loss to reduce your tax bill. 
• You can withdraw gains as cash with no effect on taxes.

Limited Company

• Business losses offset company income but not the individual income of officers, directors, and employees.
• When you withdraw gains from an LTD, they are taxed as dividends if paid as distributions (subject to NICS and PAYE) or as earnings if paid as earnings.
• Generally speaking, employee benefits received by directors and their families are taxable.

Which is Right for You?

Consider a Sole Trader structure if:

• You’re a freelancer, consultant, or running a small business with low financial risk.
• You prefer simplicity with fewer filing and administrative requirements.
• You are comfortable with personal liability.

Consider a Limited Company if:

• Your business requires limited liability protection for personal assets.
• You necessitate business growth, hire employees, or attract clients who prefer dealing with limited companies.
• You are willing to manage the extra administrative tasks and compliance requirements.

Choosing between a sole trader and a limited company can affect your business’s financial health, legal standing, and growth potential. 

Consult an accountant or business advisor to ensure you choose the structure that aligns with your goals, risk tolerance, and long-term business vision.

If you have questions about which structure might suit your business, please comment below, and we’ll be happy to help!