What is the difference between a sole trader and limited company?

Many clients arrive in my office having discussed with friends and family about starting out in business and need help understanding the difference between operating their business as a sole trader or a limited company. Every business is unique and it is important to gain proper advice to ensure that whichever business structure you choose is a suitable choice for you personally.

The major differences I feel are the most important are:

1 - Legal Entity : When you are a sole trader you personally are the business. There is no segregation between you personally and your business. All cash that belongs to the business belongs to you. The same as any debts of the business are your personal debts and if you cannot pay the debts, your own personal assets such as cash or house can be at risk to pay people you owe.

The money can be taken out of the business account when needed as drawings.

As a limited company you as a person are completely separate to the limited company. The limited company is in effect a separate legal entity. The cash received by the limited company belongs to the company and not you personally, and debts of the limited company are generally ring fenced as belonging to the limited company and not you personally.

The money can be taken out of the company by way of salary and or dividends when needed.

2 - Ownership: When you are a sole trader you are the sole owner of the company. There is no difference between you as the owner of the business and you as the worker of the business.

As a limited company, the roles of "Owner" and "Worker/Director" are separate. So you may own 100% of the share capital of the business, or perhaps 50% each with a wife or family owner, receiving a share of the profits at the end of each year (called dividends). Separately, you may then work in the business as a director or employee and receive a wage for doing so.

You can be a director and a shareholder and this is a common arrangement for small businesses.

This difference in roles can be an advantage for those businesses that want to share profits, raise investment, or involve family in helping to run the business officially.

3 - Compliance: As a sole trader your basic responsibility is to prepare a tax return to HM Revenue and Customs each year. Ideally this is supported by a set of accounts to show evidence of the figures, however this is not compulsory.

A limited company has far more compliance to meet. As it is in effect it's own person the company has to prepare it's own tax return (Corporation Tax Return) to HM Revenue and Customs as well as a set of financial accounts not only to H M Revenue and Customs but also to Companies House ( The regulator of limited companies) along with an annual statement of compliance.

It is worth noting that these accounts must be prepared under specified regulations and layouts as stipulated in Company Law and Accounting Regulation.

Finally, you then as a Director/Shareholder have to prepare your own personal tax return to HM Revenue & Customs.

4 - Trading names: As a sole trader you have little protection over the trading name you use. So if you wish to protect a really exciting, funky trading name as you have grand plans for expanding and perhaps franchising, you will have to take other advice into legal protections of such names.

As a limited company the name is automatically protected. When the company is formed the name enters the register at Companies House. This means that no other company can be formed with the same (or similar) name.

5 - Tax: As a sole trader you pay income tax and national insurance on all the profit (less the first £11,850 which is your tax free allowance, also called Personal Allowance) you make each financial year, it doesn't matter whether you have taken all the physical cash from the business bank account or left it there.

A limited company is taxed on all it's profit at the end of each financial year but you personally are only taxed on the amount you have physically taken out of the business.

The rates are different in each case, however for larger or growing businesses where the owners do not want to take all the cash out of the business each year, the limited company set up can have significant tax and national insurance savings. This is a complex area and it is always advisable to speak to a qualified accountant to work out your unique situation.

6 - Myths: There are some myths we get asked all the time by people who have been told information by friends and family. These are the top myths in regards to sole traders v limited companies. Both sole traders and limited companies CAN:

- be employers and can employ staff

- register for VAT

- own or lease property

- hold a contract with suppliers

- be registered for CIS (Construction Industry Scheme)

We hope that the above information helps break down some of the fundamental differences. It is always advisable to seek the advice of a qualified accountant in order to discuss your own personal affairs. It is worth seeking out a local accountant that can offer a free consultation.

Butlers Chartered Accountants are pleased to offer such a service and so please do not hesitate to contact me to book a free hour meeting if you feel it would be advantagous to you.

Best of luck with your new business venture.

Hayley Meagher A.C.A


Butlers Chartered Accountants

Hayley Meagher A.C.A - Director - Butlers Chartered Accountants

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