Should I Setup As A Sole Trader Or A Limited Company?

Should I Setup As A Sole Trader Or Limited Company?

Should I Setup As A Sole Trader Or A Limited Company?

Should I Setup As A Sole Trader Or Limited Company?
Should I Setup As A Sole Trader Or Limited Company?

Should I Setup As A Sole Trader Or A Limited Company?

We often get approached by individuals starting in business who are thinking about running a limited company. Entrepreneurs can hold being a company Managing Director with high esteem. Without fully considering the tax consequences. The correct path of either a sole trader or limited company will depend on several factors.

Both structures have many differences. Particularly when it comes to the tax system. We will help you understand the differences and make a more informed choice.

Sole Trader

Sole traders are self-employed. Your business may have employees. However, you as an individual and your business affairs are one and the same. Meaning you will be personally responsible for any of your business’s debts. In extreme cases, you could end up losing your home to repay debt.

The tax system for self-employed workers is also different from the limited company regime. HM Revenue and Customs require individuals and sole traders with self-employment income to submit a Self-Assessment Tax Return every year. The tax return covers the period from 6 April to the 5 April the following year.

The online tax return must be submitted to HMRC by the 31 January preceding the 5 April. The total tax liability must be fully paid by the 31 January. You will also be required to make a payment by 31 July following the 31 January for 50% of the current year’s tax liability. Please see the below example:

Limited Company

A limited company is a separate legal entity to its owners (shareholders) and director’s. This means a company has something called limited liability which protects the assets of its owners. Meaning, the company’s finances are totally separate to your own. This can be an attractive proposition for owners. Who in smaller companies tend to also be the company director’s. Directors’ are responsible for the day to day running of a company.

UK companies pay corporation tax on profits. This will be payable 9 months and 1 day from the company year-end. Although the corporation tax return is actually not required to be submitted to HMRC until 12 months from the financial year-end. The current rate of corporation tax is 19%. Meaning in basic terms a company with pre-tax profits of £100,000 would pay corporation tax of £19,000. Startup business accountants and tax advisors will calculate a company’s profits in the annual accounts. Then will prepare the corporation tax return to calculate the tax liability.

Extracting Profits

Being a sole trader means you can withdraw the money earned from the bank account tax-free. It’s much more complex taking money out of a limited company. Directors’ are recognised as employees and will pay tax and national insurance on their income dependent on the level of wages they are paid. Tax and national insurance will be paid through the PAYE system. Normally on a monthly basis.

Companies pay dividends to their shareholders. Dividends are taxed through self-assessment at the date which they are paid. Dividends are taxed at 7.5% up to the basic rate of £50,000. 32.5% at the higher rate of tax. The first £2,000 of dividends are also free of tax, this is known as the dividend allowance.

The below example is based on extracting all profits after corporation tax by way of optimal salary and dividends would pay the following to HMRC:


There can be more commercial options open to limited companies for borrowing. Sole traders rely on their personal credit rating to borrow funds. Companies can have their own credit rating to support borrowing from lenders. Although some lenders may look into the applicant’s personal credit rating. Lenders may ask for a personal guarantee to secure the funds.

Decision Time

As you can see from this article it’s far from an easy decision. If you are a one-person business with profits that are expected to stay below the basic rate tax band of £50,000 then it may be more convenient to remain as a sole trader. Not having the burden of the extra financial admin of owning a limited company. Dividends can only be extracted from profits. Therefore, if your business is not profitable. Which is not uncommon in the early years. Then you will be unable to pay dividends and will need to pay salaries, attracting tax and NI.

Tax savings reaches its peak at profits of £60,000. Therefore tax savings decreases above this amount due to extra tax on dividends at the higher rate. This is where appointing your spouse as a shareholder can be beneficial if the company shares are structured correctly.

If you expect to achieve fast growth and you as owners have assets to protect it could be beneficial to go down the limited company route. This is often a good option for businesses who expect profits to be constantly above the basic rate band and have income in excess of £100,000. Also for businesses seeking financial investment.

All limited companies should employ a suitably qualified accountant or tax advisor to look after their affairs. Engaging with a great accountant or tax advisor early will likelihood save you thousands of pounds in the long run. And can even keep you out of jail. Company directors whilst having limited liability protecting their personal finances. Have a duty to comply with the Companies Act 2006, which falls under Criminal case law. Directors who fail to maintain adequate books and records could face the following:

  • Imprisonment
  • A fine.
  • A criminal record.
  • Criminal asset confiscation proceedings.
  • Overseas travel restrictions.

We Can Help

Don’t worry. At Accounting Inc. we are here to manage all your financial admin. We’ll certainly keep you compliant. Advise you on the best structure whether that’s sole trader, partnership or limited company. We are here to be the financial arm of your business. Please feel free to contact us for a free consultation. We are here to help.

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