April 25, 2024
Full articleShould you incorporate a Limited Company or operate as a Sole Trader?
Choosing the correct vehicle for your business is a crucial decision at any time, whether starting out or looking at a restructure. The reality is that different structures suit different businesses. The most popular structures we see on a day to day basis in UK businesses are Limited Companies and Sole Traders. But, which suits your business best?
What is a Limited Company?
A limited company is a general term for a Private Company Limited by Shares. This is a type of business structure wherein owners’ assets and income are separate from the company’s assets and income; known as limited liability.
Why should you incorporate as a Limited Company?
Limited Liability
One of the key advantages of forming a limited company is that it has a legal identity of its own, separate from its shareholders and directors. This means that the company can enter into contracts, sue and be sued in its own right. The result of this is that the company’s directors and shareholders are not personally liable for the company’s debts. They have limited liability. For example, if the company were to run into financial difficulty, becoming insolvent; owing thousands to creditors; the shareholder’s liability is capped at the amount paid for the shares coupled with any unsecured loans made by the shareholder(s) to the company. Limited liability is seen as advantageous to many entrepreneurs pursuing business interests.
The ability to raise capital
By incorporating as a limited company, the company can easily facilitate a capital raise. For example, if you are running a successful business; you may encounter interest from investors wanting to inject funds into your company. By incorporating as a limited company, you are able to offer shares in exchange for cash; allowing you to raise capital that facilitates business growth.
What are the downsides of incorporating as a Limited Company?
Financial Admin
Whereas sole traders only need to file their Self-Assessment tax return once a year, limited companies have to register with HMRC for corporation tax and must also file:
- a set of accounts
- a confirmation statement
- a corporation tax return
If the company’s turnover is more than £85,000, it will also have to register for VAT. On top of this, each director will usually have to file their own self-assessment tax return. If you are set up as an employee of your company and take a salary, you will need to register the company as an employer, then set up and run payroll. These all come at additional costs.
Taxation Rules
When a limited company makes a loss, it can only use that loss against its own profits. Sole traders, however, may be able to use a loss to decrease their income tax.
Privacy
A limited company’s accounts are published on Companies House meaning they are available for anyone to view, although accounts information can be limited for small businesses. This means your figures will be visible to the public, along with your company’s registered address, Articles, directors, shareholder and PSC (person of significant control) information.
What is a Sole Trader?
A Sole Trader is a simple business structure where one individual runs and owns the entire business. There is no legal distinction between the owner and the business. The structure is commonly a vehicle of choice for individuals who are set up to embark on their journey of self-employment for the first time.
Why should you become a Sole Trader?
Convenience
The Sole Trader is the most popular business structure in the UK. One of the reasons for this is that it is very easy to begin trading. In order to set up as a Sole Trader, all that is required is to tell HMRC that you are now self-employed by registering for a self-assessment as a Sole Trader and choose your business name.
As a Sole Trader, you will have less admin work to carry out. You will need to keep accurate records of your expenses and sales, but will only need to submit a self-assessment. If your turnover is above £85,000, you may need to register for VAT.
Full Control
Being a Sole Trader means you have full control of your business operations. You run your business the way you want without interference. There are no directors or shareholders to consult before making important decisions.
Ownership of Profit
After tax, any profit your business makes belongs to you. Sole Traders do not have shareholders to split profits with. If you work alone, you have the ability to maximise your potential profit.
More Privacy as a Sole Trader
As a Sole Trader, you are afforded privacy by HMRC’s taxpayer confidentiality rules. This means that unlike limited companies, your accounts and specific details about the directors are not available for view on the Companies House website.
Organisational flexibility
If further down the line you want to become a limited company, the process is simple. This is because you do not need to dissolve your business.
What are the downsides of becoming a Sole Trader?
Unlimited Liability
The major disadvantage of operating as a Sole Trader is the fact that the owner has unlimited liability.
As there is no legal distinction between the business and the individual a Sole Trader is personally liable for any debts and losses of the business. If the business fails with debts to be paid, not only will you lose your income but you also have to pay the money owed from your personal assets. Due to the fact that your liability is unlimited when operating as a Sole Trader, you could lose your home as well as face bankruptcy as a result of your failing business.
Difficulties raising finance
As a sole trader, it can be very difficult to raise capital to expand the business.
Banks, in particular, prefer the greater accounting transparency that comes with a limited company. Because of this and the perceived risks often involved, banks may be unwilling to lend large sums to sole traders. The terms offered on any finance may not be as generous as those provided to a limited company.
In addition, unlike a company, sole traders cannot issue shares or other securities in exchange for investment. Some government schemes may also not be accessible to those who’ve set up as a sole trader.
Customer reluctance to deal with sole traders
Sole Traders are often viewed as higher risk entities than limited companies. As a result, many clients will prefer to deal with a limited company. This can mean you lose out on business by setting your business up as a sole trader.
This is particularly relevant in certain industry sectors where there is little option but to set up as a limited company. Prior to making any decision as to your business structure you should research your market to note if there are any barriers to sole traders.
This restriction may extend from customers to suppliers, who may in some cases choose not to supply goods or services to a sole trader, or will do so but on less advantageous credit terms compared with a limited company.
Lack of Tax Flexibility
Sole Traders have the same tax status as individuals with a tax-free personal allowance of £12,570 (2022). You then pay tax on income above this figure which stands at 20% between £12,570 and £50,270; 40% on income between £50,271 and £150,000; and 45% on anything above £150,000. You will also need to pay National Insurance.
This is in contrast to limited companies which are typically more tax efficient. This is due to the flexibility in how shareholders and directors are paid from limited companies. Accountants will be able to provide advice on tax efficiency for your particular circumstances.
Conclusion
Different businesses have different structural requirements. Getting the fundamentals right are the cornerstone for any business. Key to getting the fundamentals right is taking advice. The Corporate team at Gilson Gray have advised on [thousands] of company structures. Please get in touch with any questions you may have.
Look out for my comparison between Limited Partnerships and Limited Liability Partnerships in the next instalment in the series.
If you need advice on company formation, structure or any other corporate support, please get in touch.
If you would like further information regarding the topics discussed in this blog, please contact:
Joanna Millar by email: jmillar@gilsongray.co.uk or by phone: 0141 370 8116/ 07747 653 417.
Oliver Craig by email: ocraig@gilsongray.co.uk or by phone: 0141 286 2017 / 0131 516 5354
