Sole trader vs limited company: how to choose the right business structure

If you run a successful sole trader business, you may wonder whether to stay as you are or incorporate as a limited company. Both options have pros and cons from legal, tax and admin perspectives. This guide examines key factors to help decide if switching business structures makes sense.

Tax differences

Limited companies pay lower corporation tax on profits than sole traders pay in income tax. However, you’ll usually pay more tax personally when extracting profits from a company. Sole traders benefit from a £12,570 tax-free Personal Allowance, while dividends over the £2,000 allowance are taxed. Do the maths – incorporation doesn’t always mean tax savings.

Admin burden

Operating as a sole trader is administratively simpler. You must submit an annual self-assessment tax return declaring your income and expenses. Limited companies have more reporting requirements, like preparing statutory accounts, Company Tax Returns and Confirmation Statements. Directors also submit personal tax returns.

Legal status

A key advantage of a limited company is separate legal personality. Your company can own assets and enter contracts in its own right. If the business fails, your personal assets are typically protected from creditors, unless you’ve given personal guarantees. As a sole trader, you’re personally responsible for all business debts.

Raising finance

Seeking investment can be easier as a company. You can sell shares to investors without surrendering control. Sole traders would need a complex partnership agreement to secure external funding. Banks may also prefer lending to limited companies rather than sole traders.

Director duties

Becoming a company director brings legal duties around finances, reporting and insolvency. You must act in the company’s best interests at all times. Breaching these responsibilities can lead to disqualification or fines. Sole traders don’t have statutory duties, but still need to keep business and personal finances separate.

Accessing profits

Sole traders can freely withdraw cash from their business as required. But limited company directors must follow certain procedures, like paying themselves a salary and extracting dividends from available profits. While dividends are taxed at lower rates than salary, the process is more complex.

Loss relief

If your business makes a loss, sole traders can offset this against other income like employment earnings under loss relief rules. Companies can only carry losses forward against future profits. So if you have other income streams, sole trader losses could reduce your tax bill.

Privacy

Statutory accounts contain detailed financial information and director details. Once filed, they appear on public record at Companies House. Sole trader records remain private. If confidentiality around your financials matters, incorporate with care.

VAT registration

The VAT threshold is higher for companies than sole traders. This means small firms can grow larger before needing to charge and account for VAT. The current threshold is £85,000 for sole traders and £91,500 for companies.

Accounting schemes

As a sole trader, you can use cash basis accounting and other schemes like the trading allowance, simplified expenses and flat rate VAT. Such schemes reduce admin work for small businesses. However, limited companies don’t qualify, making their accounting more complex.

Capital gains tax

Sole traders pay CGT when selling assets like premises, equipment or goodwill. Various reliefs mean they can reduce or defer gains tax bills. Companies instead pay corporation tax on such disposals, without access to the same reliefs, so may face bigger tax charges on asset sales.

Closing down

To dissolve a solvent limited company, you must apply for voluntary strike-off or liquidation. The admin to close a sole trader business is simpler – once tax returns are filed, you merely notify HMRC. Shutting down an insolvent company can also be more complex than a sole trader bankruptcy.

Take professional advice

Carefully weigh up the pros and cons around suitability for investment, tax implications, reporting overhead and legal duties before switching from sole trader to company. Get expert advice tailored to your situation – an accountant can calculate likely tax differences and highlight which business structure best fits your needs as you develop.

For more information contact Ballards at 01905 794 504

Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.