Setting up as sole trader vs a limited company.

Written by Cher

October 27, 2023

So, you’ve broken from paid employment and you’ve decided to set up your own company…how exciting! There will be many choices ahead of you as you navigate a winding path from new to mature business. Amongst the first, and most important, of your early decisions will be how to set up your company. Should you be setting up as a sole trader? Or as a limited company, and what is the difference between the two?

Setting up as sole trader or a limited company, both types will need to file assessments with HMRC

Ultimately the difference between a sole trader and a limited company is ownership. As a sole trader you will own 100% of the business and have total responsibility and liability for it. Legally the business and the owner are one and the same. Whereas a Ltd company is divided into shares and once registered with Companies House becomes a separate entity in its own right. Whilst many Ltd companies are operated by more than one person, as an individual you can also set up a Ltd company and choose to be the sole operator or director. You will have limited liability for the company.

This has a significant impact on your business’s finances, and we shall look at these separately.

Setting up as a Sole trader or a limited company will both mean competing a Self Assessment tax return

The difference between a sole trader and a limited company, and what it means for your finances.

How you pay yourself as a sole trader vs limited company:

As a sole trader you are entitled to 100% of the profit. You may be the only person working in your business, or you may employ people. Either way, you will still have to pay the correct amount national insurance, the correct amount of income tax over the tax-free threshold and there may be pension requirements. However, once all your obligations are met you can take as much, or as little of the profits as you need, or want. You will be taxed in accordance with the current income tax thresholds.

Whilst you are technically one entity with your business, it is always advisable to think of yourself as a separate entity being paid by the business. This enables you to run and grow the business strategically. Whereas, if you take all the money from the business it’s easy to forget about your tax. This may result in being surprised with a big tax bill when submitting your self assessment. Likewise, you may not assign a budget for expenses, marketing and other areas that will help your business. 

As a limited company you can pay yourself a salary from the business profits. That salary will be eligible for income tax as any employee would be. However, you can also take dividends. Dividends have a lower tax threshold. Allowing you to be more tax efficient with the money you take from your business. You can maximise tax efficiencies by taking a combination of salary and dividends.

Loans, debt and investment:

Quite simply, a sole trader may find it far more difficult to obtain loans and to scale their business. It is not impossible and if you have a great business plan you may still achieve good business loan rates. However, banks seem to prefer Ltd companies. In part, this is because in cases of forfeiture a bank can refer to the filed annual accounts. The bank will know from where they can claw back their loan. Although as a director, or operator, you will not be personally liable for any business debts. Therefore your personal assets should be secure. As a sole trader your home and other assets could be used to settle your business debts if your business fails.

Additionally acquiring investment as a sole trader can been a little more difficult. To start your business, or scale up your business, you can put your own money in, accept money from friends or family and apply for a business/bank loan. So, if you have personal financial constraints, it will have a significant impact for your ability to invest in your own company. Ltd companies are more likely to be viewed favourably from various sources of investment. Including banks, private investors and other companies. What’s more, if you put your own money in as a director loan and the business fails, there may be a way of recalling your personal investment.

Accounting:

As a sole trader your accounts can be fairly simple. You register online with HRMC who will give you a unique tax reference number. You will use this number once a year to complete an annual self assessment and pay the correct amount of tax. It is always advisable to use a monthly management account system so that you can keep on top of your business’s cash flow. However, on the whole, there are far fewer rules and regulations for sole traders.

As a limited company you’ll need to prepare annual accounts and register them each year with Companies House. You will need to be compliant with Making Tax Digital and you have to file a corporation tax return and a confirmation statement. Additionally, a self assessment tax return will be necessary for each director or operator. Any losses made by the company can only be claimed against company profits. Whereas, as a sole trader any losses can be used to reduce your personal tax liability.

Setting up as a sole trader or a limited company will have an impact on your finances.


In conclusion:

There are significant differences between the financial administration of a business set up as a sole trader and one set up as a Ltd company. Both have their pros and cons, and both would benefit from the sound and expert advice of a good accountant to ensure tax is paid correctly, and the profitability is maximised. There are several other issues around privacy, closing a business and personal preference that we’ve not covered here. As it’s not always clear which company type will suit which business; it may be worth seeking advice before you set up your new business. There is no right or wrong decision but choosing between sole trader and limited company could have a significant impact on your time, your finances and how often you need to be in touch with a good accountant.

We are always excited to hear about new business plans and ideas, and we’d love to help you set up your new business in the most fitting way for your ambitions. Contact us at info@reignaccounting.co.uk or via our contact page, and we’ll have a chat about how to get you started on your path to success.


Nicole Managing Director

Nicole x

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