Sole Trader vs Limited Company: Which is better?

Is it better to operate as a sole trader, or a limited company? This is a question we get asked frequently, and it’s a good one.

Maybe you have got a business idea that you are finally ready to turn into a reality; perhaps your ‘side hustle’ is performing better than you imagined and it’s time to get serious or, perchance, you have been offered a new opportunity to undertake some work for somebody, but not as an employee.

All of these scenarios have the potential to leave you scratching your head about what setup will work best for you.

In years gone by, operating a limited company was often the obvious and most advantageous choice. Nowadays, however, the answer isn’t quite as straightforward.

Which structure is better depends on your circumstances, your objectives and existing tax thresholds; this means that not only will it differ person to person, but it could also change over time, as thresholds shift.

A good example of this is the impending change to the rate of Corporation Tax. The standard rate will increase from 19% to 25%, in 2023, and a marginal rate will apply to those with profits between £50,000 and £250,000. 

‘How is that helpful?’, you might think. True, you do need to make a decision, but also to accept that it may be a case of weighing up the pros and cons and adopting the setup that ticks the boxes that are important to you.

It’s perhaps also worth remembering that it is much easier to change from operating as a sole trader, to operating as a limited company, than it is to do the reverse.

What are the pros and cons of operating as a Sole Trader?

A Sole Trader business structure is often appealing, and a very popular choice amongst small business owners and freelancers.

Easy to set up and putting you in the driving seat from the start, you might wonder why you’d consider anything else, but it’s important that you do ponder the alternatives carefully.

Pros

• Set up is simpler and lower statutory costs. Establishing yourself as a Sole Trader is fairly straightforward. If your income exceeds £1,000 between 6^th April and 5^th April the following year, all you need to do is to inform HMRC and register as self-employed. This process does not incur costs, unlike forming a company with Companies House.
• Using your personal vehicle. As a Sole Trader there is no difference between ‘you’ and your ‘business’. What this means, is that there is no company car tax liability to take into account. You can utilise your personal vehicle and meet the associated costs, less private usage, through your business.
• Less filing responsibilities. Compared with a limited company, there are far fewer filing and administrative responsibilities to concern yourself with as a Sole Trader.

Cons

• Attracting finance. It can sometimes be tough to attract investment when you are operating as a Sole Trader. Limited companies often come with more ‘corporate’ connotations and so it becomes easier to present yourself as a ‘big business’ to interested parties – i.e. investors in this case. If they can believe in your business and have confidence in its longevity and sustainability, investors will be more comfortable with the prospect of parting with their money.
• Opportunities to implement tax-efficient strategy. For Sole Traders, tax planning opportunities can be limited as profits are taxed as they arrive. This means that where you may have one unexpectedly good year, you could breach the various thresholds and cost yourself child benefit/higher tax rates, where the following year you may have unused allowances go to waste.

What are the pros and cons of operating as a Limited Company?

Limited companies are still commonplace, despite the advantages of this particular structure having diminished in recent years, and there are millions currently operating in the UK.

The main draw of a Limited Company can often be the fact that is a separate legal entity to the individual/s running it and so too, the company’s finances are considered separate to the directors.

As with self-employment though, there are advantages and disadvantages to consider before you can be sure that this is right for you.

Pros

• Profit extraction. When operating as a limited company, you have more options to consider when it comes to drawing income from the business. You can opt to take a salary, dividends or a combination of both, and you can also choose to leave profits in your business until further down the line, when it could be more tax-efficient to extract them. For personal tax purposes, you will only be assessed on the income you extract, and not the amount of money your business makes altogether. This can be useful, for example, when you consider that you may be subject to the High Income Child Benefit Charge (HICBC) if your personal income exceeds £50,000 annually.
• Your business is a separate entity. If you opt to adopt a limited company structure, for legal purposes you and your business will be separate entities. As such, you benefit from limited liability; however, this does not absolve you of all responsibility and should not be the sole reason that you choose this route. Being the director of a company is a significant responsibility, one that carries a number of legal obligations that must be met and one that, if neglected, can lead to an inability to continue to operate and financial disrepair.
• Tax planning opportunities. A Limited Company structure comes with plentiful opportunities for tax planning, whether in respect of pensions contributions, capital expenditure, business expenses or, as referred to previously, extracting income. This is not to say that tax planning opportunities do not exist for Sole Traders, but the nature of these opportunities may differ.

Cons

• Cost of setup. As alluded to earlier in this article, the costs associated with setting up as a Limited Company are greater than those associated with setting up as a Sole Trader. You will need to pay a fee to Companies House, in order to form a company, and each year after that to file a confirmation statement. We would encourage you to seek advice when considering incorporation, as there are a number of important things to consider (and ensure you get right), such as the value and number of shares you wish to own.
• Statutory obligations and paperwork. When running a limited company, the associated administrative requirements are often more complex and time-consuming than those that come with self-employment. Each year, you’ll be required to submit company accounts, a confirmation statement, a Corporation Tax return and, potentially, a personal Self-Assessment tax return. It’s also worth bearing in mind that, if you employ staff, you will have legal obligations to fulfil there in respect of payroll and pensions (this is also true for sole traders).
• Ownership and Directorship of the company. Limited companies can be owned by multiple shareholders and have multiple directors. Whilst allowing you to share the responsibility for running the business, it also means that you are unlikely to have total control of the company and you may find that you don’t have significant sway when it comes to making decisions, implementing processes or dictating how the company should operate. There are other options available to you in terms of ownership that we do not cover in this article, like partnership, for example. We are well versed in the full range of legal structures that you can choose between and can support you whichever might be right for you.

How can George Hay help?

As you can tell, there is much to consider when it comes to making a decision about whether self-employment, or a limited company structure suits you better, and there isn’t a definitive answer.

Given that your business structure dictates so much else, it is not a decision that should be taken lightly. If you’re unsure, we would be delighted to discuss your options with you and point you in the right direction.

Once you know where you’re headed, whether down the path of self-employment or setting up as a limited company, you will then be faced with needing to get to grips with all the associated responsibilities, obligations, statutory requirements and other minutiae of running a business.

Our team of chartered accountants and business advisers, operating from offices in Cambridgeshire, Bedfordshire and Hertfordshire, have the knowledge and experience to help you operate effectively and make sound, informed decisions for the good of your enterprise and earnings potential.

We monitor legislative changes closely, which means we can ensure you are always compliant with the latest rules and utilising the newest reliefs.

On top of all that, we can relieve you of the administrative burden you may be fearing, allay any concerns you have about becoming self-employed, or a company director, and bring your ambitions within reach.

If you’re currently having the self-employment vs limited company debate with yourself, give us a call, or fill in one of our contact forms and a member of the team will be in touch.