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Sole trader verses limited company

So you are thinking of setting up in business. The first thing to say is that the decision about what trading vehicle to use is not the be all and end all. If you set up as a sole trader, you can incorporate at a later date, all be it at more cost.

This post aims to help you make that decision, at least by explaining the main differences.

Sole Trade

A sole trade is the simplest form of business. All you need to do is inform HMRC that you have started to trade, by registering for self-employment [insert link]

A sole trader is taxed on the profits of the business, regardless of whether they are drawn (paid to you) or not.

A sole trader will pay class 4 National Insurance.

A sole trader can be VAT registered, either voluntarily or because your turnover has breached the VAT Threshold, currently £85k.

A sole trader can register for PAYE and employ people. A sole trader cannot pay themselves “wages” under PAYE.

You can take money out of the business by way of drawings even if you are making losses. (Beware if the amount of capital you have the business is negative that HMRC might disallow the tax allow ability of any interest on bank loans taken out by the business)

All of your motor expenses can go through the business. A certain percentage (private use) would not be allowable for tax. That percentage is up to you, but it needs to be something that you can substantiate to HMRC.

The downside of a sole trade business is that you, personally, own the assets and liabilities of the business. This means that, should you get into difficulties, your creditors can go after your personal assets, such as your house. For a lot of people this is a key consideration.

If you wanted to run the business with a business partner, you would need to trade as a partnership.

Limited Company

A Limited Company is an entity in its own right. This means that you as the shareholder are only liable for the amount that you paid for your shares, which on set up could be £1 each. Beware though that a bank most likely will ask for a Personal Guarantee against any loan, which means that you would be putting your house on the line as much as you would as a sole trader.

A company can have more than one shareholder.

The company has to be registered at Companies House as well as with HMRC. An abbreviated version of your accounts (basically just the balance sheet) have to be filed at Companies House each year, and these are available to be downloaded by anyone who wants to see them – your creditors, your competitors or even your customers.

A company pays tax at 19% on profits under £50k, rising to 25% thereafter.

A shareholder can draw money from the business either via a salary (taxed under PAYE and subject to employers and employees NIC) or by dividends. It is important to note that dividends can only be drawn out of retained profits! so if you are making losses, you cannot take a dividend, nor can you take a dividend in the first few months of trading, until you are sure that you have made a profit. That is why good bookkeeping and management accounts are important. In addition these is certain paperwork that has to be completed before you can take a dividend.

Furthermore one would not want to take monthly dividends as HMRC could say that these are actually salary and apply employers NIC together with fines and penalties. Generally dividends are taken quarterly in arrears, so you need to be able to manage your personal cash flow.

It is also a lot more complicated if private expenses go through the business. Rather than simply disallowing them for tax purposes, you are taxed on them as benefits in kind.

A Limited Company can be VAT registered, either voluntarily or because your turnover has breached the threshold.

A Limited Company can register for PAYE and employ people.

(Updated January 2024)

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