There are a lot of factors to consider when you start your own business. One of the biggest factors to consider is what structure should you use when setting up your business. It’s a question we get asked a lot by start-up businesses – should I operate as a limited company or a sole trader?
Here’s some information to help you determine what the best option is for you.
Limited Company
Characteristics
- You and the business are separate legal entities
- The business is formally incorporated with Companies House
- The business pays corporation tax on its profits
- The business must file statutory accounts with Companies House
- Statutory registers must be kept at the registered office address
- Directors have legal duties and obligations to the business, namely fiduciary duties, such as to act in the business’s best interest
Practically what does this mean? Pros and Cons
- Pro: As a separate legal entity, and because you have limited liability, you aren’t liable for the business’s debts – you’re only liable for what you put into the business
- Pro: Once incorporated no one else can use your business’s name
- Pro: Getting investment and financing is often easier for limited companies
- Pro: The company can claim Research and Development costs back from HMRC
- Pro: There can be tax efficiencies when operating as a limited company – we’ll come back to this one
- Sometimes a Con: Costs incurred must be in the business’s name
- Con: there’s more administration with the statutory obligations
What else?
- Operating as a limited company is often seen as being more professional
- Depending on your ambition for the business, it’s easier to sell a limited company than a Sole Trader business
The tax stuff
- Limited companies pay corporation tax on their profits
- You, as the owner and director, only pay tax on the money you’ve taken from the business
- You can take money from the business as salary – which is 100% tax deductible for the business
- You can also take dividends from the business – dividends are a distribution of profit, so no profit means no dividends can be taken
- Dividends are taxed at a lower rate than income tax, and aren’t subject to national insurance
- The business can contribute to a pension on your behalf, and it’s 100% tax deductible for the business
- As an employee of a limited company you can claim Employee Trivial Benefits; £50 for an item (not cash or a voucher) purchased for you by the business – this is capped at £300 for directors
- You can also spend £150 on a Christmas party as an employee of a limited company – there’s no tax implication for you, and the business can claim it back
Sole Trader
Characteristics
- There’s no legal separation between you and the business
- There’s no formal set up, making it quick and easy to get started – you just have to register as a Sole Trader with HMRC
- There’s no statutory obligations or filings with Companies House
- You do have to file a Self Assessment annually
- You’ll pay income tax and national insurance on the business’s profits
Practically what does this mean? Pros and Cons
- Pro: there’s no statutory obligations, so less administration than a limited company
- Pro: you and the business can share costs, because you’re not separate legal entities
- Con: you’ll be taxed on the business’s profit, regardless of how much you take out of the business
- Con: it can be more difficult to get investment and financing as a Sole Trader
- Con: as there’s no separate legal entity, you’re personally liable for the business’s debts
The tax stuff
- You pay income tax and national insurance on the business’s profit, regardless of how much you take from the business
- How much you take from the business isn’t tax deductible
- The business can’t contribute to a pension for you, you must do that personally with money taken from the business
- You’re not an employee of the Sole Trader business, you are the business, so there aren’t any employee benefits
For Both Type of Business
- If you hit £85,000 of turnover in your business you must register for VAT – whether you’re a Sole Trader or a Limited Company
- Both types of business can voluntarily register for VAT
- Both types of business can employee people
Cost Comparison
As already mentioned, there are differences to the allowable tax deductible costs for limited companies and sole traders – here’s a table detailing the biggest differences
| Cost | Limited Company | Sole Trader |
| Working from home | Set amount per week dictated by HMRC (if no other office) | Can apportion an element of home costs (mortgage interest, council tax, light & heat etc) to the business |
| Mobile Phone | Business pays – 100% tax free benefit for you personally | Apportion the percentage of business use to the business, the rest is yours |
| Car Costs | Claim 45p per mile from business as expenses* | Either mileage or percentage of car costs (insurance, fuel, servicing etc) |
| Home Internet | Must be in the business’s name | Can apportion the percentage of time it’s used for the business |
Are you a start up business?
Would you like to know more about business structures? Or work through the tax scenarios with some numbers? Get in touch CONTACT US.