The differences between a Sole Trader and a Limited Company
Each structure has advantages and disadvantages which are outlined below to help you choose the best option for your circumstances.
A limited company is its own legal identity, so as a shareholder your liability is limited (hence the name ‘limited by shares’).
As a sole trader, there is little distinction between you and the business. Any business debts become your debts and your personal assets – including your house – are not protected.
In a limited company, tax is deducted from directors’ salaries via Pay As You Earn (PAYE) and paid at regular intervals to HM Revenue & Customs (HMRC). All directors are also obliged to complete a tax return unless they received absolutely no pay or benefits; irrespective of whether any tax is owed. If the directors are also shareholders, they may receive dividends from the company. From 6 April 2016, a new rate of dividend tax is payable by shareholders on dividends above £5,000pa under the self-assessment regime.
For limited companies of any size, corporation tax is charged at 19% from 1 April 2017 (20% up to March 2017). Corporation tax is payable 9 months after the year end and a company tax return must be filed 12 months after the year end.
Sole traders pay tax on their business profits, via the self-assessment tax return system. The deadline for online tax returns is 31st January after the end of the tax year.
Within a limited company, both employer’s and employee’s National Insurance (NI) is payable on directors’ salaries and bonuses. This NI charge is greater than that paid by a sole trader/partner, who pay Class 2 NI contributions of £2.85 per week and Class 4 contributions on profits in excess of £8,164 (rates accurate for 2017/18).
Tax bands and rates
For a sole trader/partnership, the personal allowance has been increased to £11,500. This is the amount that can be earned before paying any income tax at all.
For income in 2017/18 above this threshold, a sole trader/partner will be taxed at the following levels:
The Basic rate of 20% on income up to £33,500*
The Higher rate of 40% on income between £33,501 and £150,000
The Additional rate of 45% on income over £150,000
*For Scottish taxpayers the higher rate band starts at £31,500
For the 2017/18 tax year £45,000 (£43,000 in Scotland) can be earned before the higher income tax rate of 40% is paid. This being the £11,500 personal allowance plus the basic rate threshold of £33,500 (£31,500).
The new dividend tax on amounts above £5,000 are taxed at the highest level as follows
7.5% at the Basic rate up to £33,500
32.5% at the Higher rate between £33,501 and £150,000*
38.1% on income over £150,000
In a limited company, losses can only be carried forward and set against future profits or set against the previous year’s profits. For sole traders, losses can be set off against other income in the same tax year, carried back to previous years or carried forward against future profits.
Accounts and tax returns
A limited company must prepare annual accounts (also known as ‘statutory accounts’) from the company’s records at the end of the financial year. These are filed with HMRC as part of the company tax return and sent to all shareholders and Companies House. A limited company must also file a Confirmation Statement with Companies House, which includes information about the directors, shareholders and registered office.
Sole traders/partners are not legally required to have or file annual accounts but they still have to keep a record of business expenses and income to fill in their tax returns.
An incorporated company, whilst not guaranteeing reliability, gives the impression of a soundly based organisation and may appear more credible. In certain sectors, contractors or agencies may not work with sole traders because of the legal protection a limited company provides.
This page should have helped you answer some important questions, including; “what is a sole trader business?” and “what is a limited company?”.
As you can see, being a sole trader business and a limited company are two completely different things. Strictly speaking, you can’t have a sole trader company as the word ‘company’ should only be used when you’ve registered your business with Companies House. It’s worth pointing out that it is possible to make the move from sole trader to limited company.
There are advantages of being a sole trader and there are advantages to being a limited company.