Whether you are a start up or an unincorporated enterprise reviewing its business structure, the question you may be asking is, “Should I set up a limited company or am I better off as a sole trader?”
Unfortunately, there are no easy answers – what is right for one business may not be right for another, but these are some of the factors you should consider when making the decision. And don’t be afraid to get professional advice, especially on the tax position of your business; your accountant or tax advisor should help you to make an informed decision.
1. Simplicity
Being a sole trader is by far the easiest form for a business. You must register as self-employed with HMRC, keep accounts of income and expenditure, and submit a self-assessment tax return every year. There are no registration fees and no requirements to be audited or to file accounts.
A limited company, on the other hand, must register with Companies House and file accounts annually. In addition, it must maintain statutory books and submit an annual return to Companies House.
2. Flexibility
It is easy to set up as a sole trader. It is also very straightforward to cease trading. All that is required is to notify HMRC of the change in your business, allowing you to stop easily if your circumstances change, without the hassle and cost of deregistering a limited company.
3. Privacy
A sole trader is not required to file accounts or register a business with Companies House, keeping your business affairs private. Even small companies must file their accounts and submit an annual return, making certain details public knowledge.
4. Risk
A sole trader’s private assets are at risk if the business fails. There is no legal separation between the business and its owner, making a sole trader personally liable for the business debts. A limited company, on the other hand, is a separate legal entity and the owner’s liability is capped. Their liability is limited to the value of their shares, or a fixed sum in the case of a company limited by guarantee.
However, incorporating does not always remove the risks associated with being a sole trader. Directors of small companies are frequently asked to give personal guarantees to secure business bank loans.
5. Succession
It may be preferable to incorporate if you want to sell the business or pass it on in the family. A limited company may be a more attractive proposition than an unincorporated business, making it easier to sell. A sale can be completed easily by the transfer of shares.
6. Tax advantages
As a sole trader, if your business makes a loss, this can be offset against other income; a company can only offset its losses against its own profits from other years.
However, there may be tax advantages in operating an owner-managed limited company. As a sole trader, all your profit is taxed as income on the individual. , Income can be withdrawn from a company in two ways: as a salary, subject to tax and national insurance or as a dividend. Dividends are paid out of profits after corporation tax has been paid, which is more tax efficient.
Dividend payments can only be made out of retained earnings, so if there is no profit, you cannot pay a dividend. The board of directors must approve each dividend and officially record it in the company’s minutes.
7. Credibility
Some people feel that a limited company structure gives more credibility with customers, suppliers and banks.
