When starting a small business, it’s essential for you to make a decision on the structure that suits your operation. It can either be a self-employed (sole trader), a limited company or a partnership. Setting a business up as a sole trader has become the foremost popular legal structure within the UK. There were approximately 3.5 million sole proprietorships registered in 2019. Sole traders accounted for 60% of small businesses within the UK. Also in the UK, there are over 1.9 million limited companies, making it the second biggest legal structure.
It is very important to consider the pros and cons of the different legal structures before deciding your business structure.
What is a Sole Trader?
A sole trader is a self-employed person who is the sole owner of their business. It’s a simple business structure which allows someone to carry out his/her trade(s) without the need for registering the business with companies house. The owner and the business are one. You can set up as one by contacting us here at Carrington Blake Accountancy to assist you or via the GOV.UK website (you’ll need to do this for tax purposes).
What is a Limited Company?
A limited company is a business structure that has its own legal identity. The owner(s) and the business are different persons. A limited company is owned by the shareholder(s) and managed by the director(s). The directors can also be the shareholders. Each shareholder’s right is determined by the type and number of shares held. A limited company is required to register their business with companies house before using the word “limited” in their name.
Sole Trader vs Limited Company
Now, putting in place either structure will bring its own benefits and weakness. Here are the benefits and drawbacks of both the business structures.
Sole Trader Advantages:
- Easy to set-up and moderately little paperwork, other than an annual self-assessment tax return.
- Greater privacy than incorporated businesses, whose details are often found via Companies House.
- For Capital Gain Tax purposes, a sole trader receives an annual allowance. The annual allowance for 2020/21 is £12,300. CGT will be charged only on the gains above the annual allowance.
Sole Trader Disadvantages:
- Sole traders have unlimited liability, as they’re not viewed as a separate entity by UK law. This implies that if the business gets into debt, the business owner is personally liable. As such, sole traders could lose personal assets if things go wrong.
- Raising finance can be tricky, as banks and other investors tend to prefer limited companies. This limits the expansion opportunities of sole traders.
- Tax rates on sole traders aren’t always as kind as they are on limited companies. When you reach a certain level of earnings, it might not be quite as lucrative to stay a sole trader.
- The rate for Capital Gain Tax will be determined by total income level in the tax year. For 2020/21, the applicable tax rates are 10%,18%, 20% and 40% depending on the type of asset sold and your income level – basic or high earner.
Limited Company Advantages:
- Unlike a sole trader, a limited company has the benefit of limited liability, as incorporation forms a legal distinction between the business owner and their business. This means that personal assets aren’t exposed – you only stand to lose what you put into the company.
- Broadly speaking, limited companies stand to be more tax-efficient than sole traders, as rather than paying Income Tax they pay Corporation Tax on their profits. As things stand this offers a kinder tax rate, meaning forming a limited company can be more profitable. In addition to this, there’s a wider range of allowances and tax-deductible costs that a limited company can claim against its profits.
- Once you’ve registered a company name nobody else can use it, in contrast to sole traders who aren’t offered the same protection.
- The Capital Gain Tax rate for a limited company is fixed. The current rate for 2020/21 is 19%.
Limited Company Disadvantages:
- Life as a limited company brings added responsibilities. These come in the form of what’s called the Director’s Fiduciary Responsibilities, which basically outline what a limited company director must do legally. You will need to file a yearly annual return for one, as well as annual accounts.
- Thanks to these added responsibilities going limited can be costly and time-consuming, as you’ll need to either deal with this extra paperwork yourself or hire an accountant to handle it. You’ll need to pay a fee to incorporate too, email us on email@example.com for more information.
- In contrast to sole traders, information on your business can be found via Companies House, details on directors and your company’s earnings required to be shown publicly. This sort of transparency may not appeal to all.
- There is no annual allowance for CGT purposes.
How can Carrington Blake Accountancy Help Me?
If you are planning on taking the leap in becoming a small business and would like consultancy advice from one of our expert accountants, you can contact us on 0207 537 6628 to talk to one of our professionals to go through the differences between being a sole trader or as a limited company. Alternatively, you can chat with one of our experts here.
Our accountants will also be able to provide step-by-step help in setting up your company for you, and also discuss the full tax implications of both structures, so you will have expert guidance along the way.