THE DIFFERENCES BETWEEN A SOLE TRADER AND A LIMITED COMPANY
This document should help you answer some important questions, including; “what is a sole trader business?” and “what is a limited company?” and the differences between the two.
Starting up as a sole trader is without doubt the simplest way to start a business in the UK. All you need to do is inform HMRC that you are working as ‘self-employed’, and account for your business activities through the annual self-assessment tax process.
Setting up a company as a Limited company involves a more complex formation process, and the financial and administrative responsibilities of running a limited company are certainly greater than those of a sole trader.
There are advantages and disadvantages to both the self-employed and the limited company routes. Which option is best for you depends on your own particular circumstances so it’s important to look at the key differences between these two business structures;
An incorporated Limited company, whilst not guaranteeing reliability, gives the impression of a soundly based organisation and may appear more credible. In certain sectors, contractors or agencies may not work with sole traders because of the legal protection a limited company provides.
It’s worth pointing out that it is possible to make the move from sole trader to limited company.
DISTINCT ENTITY / LIABILITY
A limited company is its own legal identity, so as a shareholder your liability is limited (hence the name ‘limited by shares’). The company is a completely separate entity from its owners therefore everything from the company bank account, to ownership of assets and involvement in tenders and contracts is purely company business and separate from the interests of the company’s shareholders.
A sole trader and his/her business is treated as a single entity for tax and administrative purposes. Any business debts become your debts and your personal assets – including your house – are not protected.
In a limited company, tax is deducted from directors’ salaries via Pay as You Earn (PAYE) and paid at regular intervals to HM Revenue & Customs (HMRC). All directors are also obliged to complete a tax return unless they received absolutely no pay or benefits; irrespective of whether any tax is owed. If the directors are also shareholders, they may receive dividends from the company. From 6 April 2016, a new rate of dividend tax is payable by shareholders on dividends above £5,000pa under the self-assessment regime. For limited companies of any size, corporation tax is charged at 19% from 1 April 2017 (20% up to March 2017). Corporation tax is payable 9 months after the year end and a company tax return must be filed 12 months after the year end.
Sole traders pay tax on their business profits, via the self-assessment tax return system. The deadline for online tax returns is 31st January after the end of the tax year 05 April.
Within a limited company, both employers and employee’s National Insurance (NI) is payable on directors’ salaries and bonuses. This NI charge is greater than that paid by a sole trader/partner, who pay Class 2 NI
TAX BANDS AND RATES
Contributions of £2.85 per week and Class 4 contributions on profits in excess of £8,164 (rates accurate for 2017/18).
For a sole trader/partnership, the personal allowance has been increased to £11,500. This is the amount that can be earned before paying any income tax at all.
For income in 2017/18 above this threshold, a sole trader/partner will be taxed at the following levels:
- The Basic rate of 20% on income up to £33,500*
- The Higher rate of 40% on income between £33,501 and £150,000
- The Additional rate of 45% on income over £150,000
- *For Scottish taxpayers the higher rate band starts at £31,500
For the 2017/18 tax year £45,000 (£43,000 in Scotland) can be earned before the higher income tax rate of 40% is paid. This being the £11,500 personal allowance plus the basic rate threshold of £33,500 (£31,500).
The new dividend tax on amounts above £5,000 are taxed at the highest level as follows:
- 5% at the Basic rate up to £33,500
- 5% at the Higher rate between £33,501 and £150,000*
- 1% on income over £150,000
In a limited company, losses can only be carried forward and set against future profits or set against the previous year’s profits. For sole traders, losses can be set off against other income in the same tax year, carried back to previous years or carried forward against future profits.
ACCOUNTACY AND TAX RETURNS
A limited company must prepare annual accounts (also known as ‘statutory accounts’) from the company’s records at the end of the financial year. These are filed with HMRC as part of the company tax return and sent to all shareholders and Companies House. A limited company must also file a Confirmation Statement with Companies House, which includes information about the directors, shareholders and registered office.
Sole traders/partners are not legally required to have or file annual accounts but they still have to keep a record of business expenses and income to fill in their tax returns.
Once you register your company with Companies House, your company name is protected by law. No-one else can use the same name as you, or anything deemed to be too similar.
As a sole trader, it’s possible someone else could trade under the same name as you, and you couldn’t do anything about it. This could damage your business, and in some cases, result in you having to go through the costly and time-consuming effort of changing the name of your business.
A limited company can issue various classes of shares. This means you can easily sell stakes in the company, or transfer ownership of shares.
If your limited company has more than one shareholder you should get a Shareholders Agreement.
If a shareholder wishes to retire, sell his shareholding, or dies, it is far easier to transfer ownership of a limited company than a non-registered business structure.
A limited company can fund its employees’ executive pensions as a legitimate business expense. This can offer a tax advantage over those who are running their business as self-employed.