If you decide to move to self-employment, you’ll need to choose a legal structure for your new business – in the UK, the vast majority of small businesses are either sole traders or limited companies. So, what are the differences and which should you pick?

Sole trader

Being a sole trader is, overall, simpler, and for this reason is the more popular choice.  Sole traders account for around 60% of small businesses in the UK. To set yourself up as a sole trader, you need simply to register for self-assessment with HMRC.  You also need to be VAT registered if your turnover exceeds £85,000 annually.

As a sole trader, you will keep records of your income and business expenditure, and use these figures to calculate your profit.  This profit is then declared on your self-assessment tax return and you will pay tax accordingly – much less hassle than a monthly payroll.  You also won’t need to submit annual accounts, as a limited company does.  You can withdraw your cash profits from your business bank account any time you like.

Limited company

A limited company undeniably requires more work. To set up, you’ll need to write up your articles of association (documents outlining how your company will be run), register with Companies House, and register with HMRC for corporation tax and PAYE. VAT too, if your annual turnover will exceed £85,000.

Once you’re up and running, you’ll need to put yourself on payroll.  You’ll deduct PAYE and NI from the regular payments you make to yourself. Any further withdrawals must be recorded as a Director’s Loan, which is a whole other blog post. You’ll need to file your accounts annually with Companies House and also file an annual Corporation Tax Return to pay tax on your profits. Available profits are then withdrawn as dividend payments, which also require written records (dividend vouchers).  Dividends are declared on your personal self-assessment and taxed accordingly.

Advantages of a limited company

With all this extra work, why would anyone choose a limited company over a sole tradership? There are several reasons:

A limited company is considered a separate legal entity from its owner(s), whereas a sole partnership is not. This means that, should the worst happen, a sole trader can find themselves personally liable for debts incurred by their business. Some of this risk can be mitigated with appropriate insurance, however it can only be avoided by setting up the business as a completely separate entity. The owners of limited companies do not need to worry about their personal assets, such as their homes, being used to pay business debts if their business happens to fail.

While this is dependent on personal circumstances, business owners may personally pay more tax as a sole trader. Sole trader income is entirely subject to income tax rates, however the director of a limited company will be paying themselves partly in dividends.  This usually results in a lower tax liability overall.

In certain sectors, contractors and agencies prefer to work with limited companies because of the legal protection discussed above.  Incorporated companies tend to give the impression of a reliable, established company more than sole traderships do.

So, to sum up – there are up sides and down sides to both structures.  It is worth taking the time to decide which is right for you. There are also some variants to consider such as partnership and limited liability partnerships.

Exonia works with many clients of both types and we are very familiar with the advantages and disadvantages.  If you are considering self-employment, feel free to get in touch with us for advice tailored to your situation.

Categories: AccountingUK