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Sole Trader vs. Limited Company — What's the difference?

November 24, 2021

When starting your entrepreneurial journey, one of the first things you need to do is decide your business's legal structure. This might seem like a pretty straightforward decision to make, but choosing the right business structure can affect everything from how and when you pay your taxes to what happens if your company gets into trouble.

This isn't to say that the business structure you choose is set in stone. Many small businesses often start out as a sole trader business and eventually switch to a limited company once their earnings increase. You can find out exactly how to do this in our article 'How to change from a sole trader to a limited company.'

However, depending on the nature of your business, you might find it beneficial to operate as a limited company from the very beginning. In this article, we dive into what the difference between a sole trader and a limited company is, the benefits and drawbacks associated with each business structure, and how you can choose the right business structure for you.

What is a sole trader?

The more popular option of the two, a sole trader is a self-employed person who runs their own business as an individual. This means that they are entirely in control of the direction the business takes, and can keep all of the company's profits. Sole traders can choose to hire staff, but ultimately the business is theirs and theirs alone.

Benefits of being a sole trader

Simple set up

One of the most attractive reasons for setting up as a sole trader is that it is so easy to do. Simply notify HMRC that you pay tax through Self Assessment, make sure you have the tools in place to record your profit and loss, income and expenses and start trading. To see just how easy it is, check out our step-by-step guide on registering as a sole trader.

Privacy

Sole traders also get a lot more privacy than their limited company counterparts. While sole traders only have to notify HMRC that they are trading, limited companies must register with Companies House, and once registered will have their company's information readily available to view on their website.

Offset losses

If you're expecting to make a loss in your first few years of trading, you might find it more beneficial to operate as a sole trader. While limited companies cannot claim back on their losses, sole traders are able to set their losses against other income or gains for the current or previous tax year, and if the sole trader is in their first four years of business they can carry their losses back as far as three years. To find out more about claiming back on sole trader losses, visit our article on tax saving tips for sole traders.

Drawbacks of being a sole trader

Unlimited liability

While you are in complete control of your company as a sole trader, in the eyes of HMRC you and your business are a singular entity, meaning that you are personally responsible if anything goes wrong. As a result, if your company falls into financial trouble, your personal finances and personal assets can be used to pay off outstanding debts.

Less tax efficient

Sole traders can also expect to see the amount of tax they pay rise substantially as their income increases. Alongside a weekly flat rate set by the government for paying Class 2 National Insurance, sole traders must also pay Class 4 National Insurance and Income Tax, with the amount determined by their taxable profit. This means that sole traders with a taxable income above £50,271 will fall into the higher rate Income Tax band, with a tax rate of 40%.

What is a limited company?

A limited company is a business owned by shareholders and directors — even if the company is run by just one person acting as shareholder and director.

Benefits of being a limited company

Limited liability

As mentioned above, while sole traders are seen as a singular entity with their business, limited companies are seen as a separate legal entity altogether, meaning that if the business gets into trouble the owners' personal finances are not at stake. Since the company is owned by shareholders, the owners only stand to lose what they invest in the company.

More tax efficient

Moreover, many business owners may find it more lucrative to operate as a limited company, especially those with sizeable profits. While the amount of Income Tax a sole trader pays is dependent on their income minus their business expenses — which for additional rate sole traders can be as much as 45% — limited companies instead pay a flat 19% in Corporation Tax on their profits, regardless of how large their profits are.

Name claim

For those looking to set their business apart from the rest, limited company names, once registered, cannot be used by anyone else — helping your business to stand out. If you're interested in finding out whether or not your business name is available to claim, try out our free company name checker. 

Drawbacks of being a limited company

Publicly available information

One aspect of operating as a limited company that many business owners find unsettling is the amount of information that is readily available to the public. Once the company has registered with Companies House, the information about that company remains on the website indefinitely, including the company's registered address and the full names of the company directors.

Limited autonomy

For companies that choose to have more than one shareholder, the director of a limited company may find that the influence they have over their business is restricted. While sole traders are entirely free to determine the direction their business takes, limited company founders must compromise with the interests of their shareholders, ultimately capping the control they have in decision making processes.

A lot of paperwork (unless you're with Ember)

Unlike sole traders who only have a Self Assessment tax return to worry about, limited companies deal with a lot of paperwork. Once registered with Companies House, the limited company must prepare and file statutory accounts in the format prescribed by the Companies Act, and must subsequently complete a Confirmation Statement each year informing Companies House of any updates or significant changes that have happened in the last year. Limited companies must also file Corporate Tax returns and annual accounts on a yearly basis, with supporting calculations needing to be provided.

As a result of the above, limited company owners may find themselves stretched thin between running a business and keeping on top of their business admin. This would previously have meant that limited companies would have had to splash out on an accountant and an accounting software, but with Ember automating the accounting for you for just £79+VAT a month, limited company owners can cross this off of their list of things to worry about.

Sole trader vs limited company

If you're still not sure whether you should operate as a sole trader or a limited company, we've come up with a few questions to ask yourself to help you come to a decision.

  • Does having company information publicly available worry you? If you'd rather keep your business details private, you might prefer to operate as a sole trader.
  • How important is it to you to limit your exposure if a claim is made against the business? Limited company shareholders only stand to lose what they invest in the company, whereas sole traders risk losing their assets if they cannot afford to settle claims or pay outstanding debts.
  • Do you expect to make a loss in the early years of trading? Sole traders can claim back on tax to offset any losses made.
  • How much do you expect to make in profits? If you're expecting a profit of over £50,271, you might find it more tax efficient to operate as a limited company. Sole traders must pay tax on their business profits (minus expenses) and can be taxed up to 45%, whereas limited companies paying Corporation Tax are only taxed 19% on company profits.

Whichever business structure you choose, Ember is ready to support you. With super-smart software automating your accounting, and a team of qualified accountants on hand to help whenever you need it, keeping on top of your taxes has never been so simple.

Join us in creating the new age of accounting.

Simple language, simple software, so that you can spend less time dealing with admin and more time focusing on what really matters.

Aaron Shaw

A full stack software engineer and designer by trade, Aaron has built a range of compelling web and mobile solutions for both small startups and large corporations across the globe, including the likes of Google, Red Bull and Unilever.