There are 3.2 million sole traders in the United Kingdom. With an easy set-up process, becoming a sole trader allows many to become their own boss quickly and easily. But do you know the difference between that and a limited company? When you are starting on a new venture it can be hard to know where to begin. Read on as we discuss the differences between sole traders and limited companies.
A sole trader is a self-employed person who is the only owner of their business. It is the simplest of all the business structures and one of the easiest to set up. Using this structure has few administrative requirements but may exclude you from certain benefits. When you are a sole trader, your taxes are submitted as an annual self-assessment tax return. Income tax is paid on any money you earn as you would do with any company. This comes from the profits generated by the business, regardless of the decision to take it out or leave it in the company itself.
When you set up as a sole trader, the process is extremely simple. All you need to do is to let HMRC know about your change in tax status. An accountant can help guide you through the process.
Once you are set up you are not bound by the compliance of a limited company. This means you have less to do from an administrative perspective.
When you become a sole trader you are legally responsible for all your finances. If the company gets in debt, this is also your debt. That means you could lose personal assets or take on a poor credit rating. If your business grows, being a sole trader can become untenable. Many growth opportunities are limited since you don’t have the credibility of public accounts.
When your turnover reaches a certain level it also becomes more viable to become a company for tax purposes and profit.
A limited company is a very specific type of business structure, with its own tax and legal implications. It has both shareholders and directors and can operate separately from them. When you start a limited company you pay a type of tax. This is known as a corporation tax. All business finances will be kept separate from personal ones in a different account. There are a lot of documents you must keep to comply with corporation tax regulations. Annual statutory accounts must be recorded meticulously. Every year you must submit a company tax return to HMRC and a confirmation of your business to companies house. Regardless of the decision to be a sole trader or limited company, you must register for VAT if annual turnover exceeds a certain threshold. This is currently £85,000.
While setting up a limited company takes a lot more time and effort, it comes with several advantages. The first is that there is a wide range of allowances allowed for limited companies and a lower rate of tax. This can mean less paid in tax for your business which means more revenue for the company.
As the business is legally separate from your personal finances, neither impacts the other. Your assets won’t be at risk if the business fails.
Another advantage is that when you register a company, it prevents others from using the same name. Competitors can not incorporate your business name and you have the exclusive right to use it.
The main disadvantage is that setting up a limited company takes a lot of time and effort. Paperwork has to be completed and evidence of compliance must be submitted. You will need business advisors, accountants, and lawyers which also cost money.
Limited companies are also legally obliged to place their financials in the public domain. This gives you less privacy compared to a sole trader who does not have to disclose their finances.
It is possible to switch from being a sole trader to a limited company at a later date. There are several reasons you may wish to do so. However, it is always recommended that you get solid business advice.
When your profits begin to reach a certain threshold it will make more sense to change. You may wish to expand and raise business funding, which a limited company can do more easily.
Raising the reputation of the company in the eyes of competitors and customers may also be a reason. This will allow you access to new talent and recruit on a wider scale.
The structure you choose can have a huge impact on everything, namely the tax structure and profit you make. Ultimately, the decision comes down to the type of business you are setting up.
If you are starting on your own and plan to employ only yourself, then you should become a sole trader. If profits will not be huge in the first few years, you can start as a sole trader and consider switching later. Should you be planning on having a larger turnover and workforce, a limited company may be the best choice.
You should also be aware that these are not the only types of company structures. Should you feel neither suit perfectly, speak with our accountancy firm. We will give you the best advice possible and help guide you through the situation.
Now you know the main difference between sole traders and limited companies, get professional advice. This is only an overview and the details are much more intricate. You can then start your new business with confidence and peace of mind.
We will be more than willing to help. We have packages for all business structures to get you up and running. Contact us for free initial consultation.