Tax & admin · 2 June 2017

The difference between a sole trader and a limited company

Limited company structure
A limited company structure has greater legal protection

For the founders of new companies, it can be difficult to know how best to structure a business. To help you choose the right option for your circumstances, Business Advice has outlined the difference between a sole trader and a limited company.

At a glance, the difference between a sole trader and a limited company is that the latter is its own legal entity, and the liability of owners or shareholders is therefore limited as a result.

On the other hand, as a sole trader there is little to legally disassociate you from your company. Essentially, you are your business, and any debt your firm incurs becomes your personal debt, whilst personal assets, such as your house or your car, are not protected.

Filing accounts

When it comes to filing company accounts, the difference between a sole trader and a limited company is the information each must submit for inspection.

A limited company must prepare annual (or “statutory”) accounts based on company records at the end of every financial year. These must be filed with HMRC, as part of an annual tax return, and be sent to all shareholders as well as Companies House.

Limited companies must also file an annual return with HMRC, with details of company directors, shareholders and registered premises.

By contrast, sole traders are not legally required to submit annual accounts for inspection, however information about business expenses and personal income is required when submitting annual tax returns.

Taxes

Limited companies are obliged to implement a pay-as-you-earn (PAYE) system, whereby tax is deducted from directors’ salaries and paid to HMRC at regular intervals.

Unless no pay or benefits were received by an individual, all company directors must file annual tax returns, irrespective of whether any tax is owed. Corporation tax is payable nine months after the end if a tax year, and company shareholders may be required to pay higher rates of tax on dividends under HMRC’s self-assessment regime, if applicable.

Sole traders are required to pay tax on their business profits, according to the government’s self-assessment tax return system, after expenses have been deducted. The deadline for online self-assessment tax returns is 31 January after the tax year ends.

National insurance

Another difference between a sole trader and a limited company is the amount workers must pay in national insurance. In a limited company, national insurance contributions of both a director and employee are payable on directors’ salaries and bonuses. This rate of national insurance is greater than that paid by a sole trader, who must pay Class 2 contributions of £2.80 per week and Class 4 contributions, dependent on profits, in excess of £8,060.

Profits and losses

In the UK, limited companies of any size are required to pay corporation tax, which for the 2017/18 tax year is set at 19 per cent of total profits.

Since profit made by a sole trader is considered personal income, the rate of tax sole traders must pay on their profits depends on the income tax bracket they fall into.

In 2017/18, the personal allowance has been increased to £11,500. This is the amount sole traders can earn in a year before having to pay any tax on it.

For any income above £11,500, sole traders are taxed as follows:

  • 20 per cent on income up to £45,000
  • 40 per cent on income between £45,001 and £150,000
  • 45 per cent on income over £150,000

Credibility

Another important difference between a sole trader and a limited company is that limited companies tend to appear more credible, both to customers and HMRC. There is significantly more protection involved when dealing with a limited company. In some instances, potential clients may hold back from engaging a business that isn’t credible in this way.

The difference between a sole trader and a limited company is large, and there are advantages and disadvantages to both structures. Which structure is best for your business depends entirely on your specific circumstances.

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ABOUT THE EXPERT

Fred Heritage is deputy editor at Business Advice. He has a BA in politics and international relations from the University of Kent and an MA in international conflict from Kings College London. He previously worked as a reporter at Global Trade Review magazine.

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