Differences between a limited company and sole trader

When you opt to start a business, you must consider the legal structure of said company. Determining this will affect tax levels and protection for you as an owner. As such, this is a priority for all startup businesses. This article will outline the sole trader vs limited company argument, and what you can expect from both business formations.


Run business as a limited company or sole trader?

As mentioned above, there are many key differences to a sole trader and limited company.

Sole trader vs limited company

There are many differences between an unregistered and registered company, and you must weigh up both options before opening your company. Before doing so, we suggest speaking to industry peers and gaining valuable financial advice from accountants, for instance, to understand truly the advantages, disadvantages and costs of both. More information can be found here.

A limited company, or registered company, is registered at Companies House. Therefore, the business is a separate legal entity from the directors and shareholders, thus protecting them of any liabilities should the company fall into arrears. An unregistered company, or sole trader, is not defined as a separate entity, but merely an extension of the directors and shareholders. As such, you are personally responsible for any debts should the company face financial issues.

Limited company

Separate legal entity

Speaking of a separate legal entity, this is one of the primary limited company advantages. Third parties will enter into contracts with the company rather than the owners. As such, a limited company provides protection to those in charge, but the same cannot be said for sole traders. If the company falls into arrears with creditors, those same creditors can personally target you for the debts. The business liabilities will fall on you as an individual.

Limited liability

The above point takes us to the advantages of limited liability. Personal liability for directors overseeing companies that have entered insolvency procedures is limited. The finances of those directors and shareholders are completely separate from the business, thus the advantages of limited liability are evident as directors will not be liable for the debts. Only in a case where fraud or misconduct is identified, will the directors be at personally liable or at risk of being personally liable.

The advantages of limited liability do not apply to sole traders. If your company cannot pay its debts as they fall due, you will be required to pay off those debts from your personal funds.

Limited company tax benefits

There are particular limited company tax benefits, as the business structure can be more tax efficient than that of a sole trader. For instance, directors of limited companies can take some of their salary as dividends. These dividends are not subject to any National Insurance contributions.

The flexibility of a limited company structure also allows for limited company tax benefits in the form of income deferral. For example, a contractor could defer income from a tax year with a high rate of tax payable, and defer to a tax year in which a lower rate is due. Therefore, income deferral can save a significant amount. However, a limited company does have to pay corporation tax, currently set at 19% but expected to fall to 18% in April 2020.

Low-cost formation

Setting up a limited company is perceived to be a very time consuming and difficult process. However, you can set up a limited company from as little as £15. The initial expense may not be as high as previously thought, but you will, likely, have to bring in an accountant to ensure you pay taxes when due, and have a realistic forecast set up. Be sure to factor in yearly accountancy costs to your cost-benefit analysis.

Pensions

Contributing to a pension can bring significant limited company tax benefits. For instance, pension contributions can be treated as an allowable business expense. As such, the contributions can be offset against your corporation tax. Likewise, when you pay money into your pension, you receive tax relief that reflects the rate on income you pay into the pension.

However, as a sole trader, it can prove more challenging to choose a pension scheme, particularly as there is no one to help you do so. Similarly, irregular income patterns – especially for those companies at the beginning of their business life – and lack of employer contributions can make the situation more difficult.

Intellectual property

As mentioned above in the sole trader vs limited company argument, the limited company is a separate entity. Therefore, the business is registered at Companies House, and the name cannot be used by any other company – affording it certain protection. However, you must err on the side of caution when becoming a sole trader, as there are no restrictions on other companies using your business name.

Finance

Other limited company advantages relate to funding. Generally, limited companies find it easier to access finance. Registering as a limited company offers a certain reassurance to lenders, and suggests the company is of much lower risk than someone setting up as a sole trader. In some cases, sole traders may have to pay higher interest to gain loans. Similarly, they may also have to offer personal guarantees on the debt to ensure the lender receives their money back, even if the company enters insolvency.

Ultimately, there are many things to consider in the sole trader vs limited company argument. To ensure you opt for the most suitable options for your business, you may find that speaking to industry peers and accountants can offer excellent insights. If you are already operating but feel that the structure isn’t working for your business, or your company is facing financial issues, our business rescue experts will be happy to discuss your individual circumstances with you.

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