Sole Trader vs Limited Company

When starting up in business, it is often the first decision to make as to whether you trade as a sole trader or incorporate a limited company. Making the decision as to which structure your business operates will generate thoughts around potential tax savings, perception to the outside world or considering future plans you may have.

Trading as a sole trader would mean taking 100% risk as an individual for the running of the business as you will be personally liable for all debts and liabilities or in the event of a legal dispute. Alternatively, trading through a limited company provides a measure of protection between shareholders and customers.

Please see comparisons between the two forms of trading as follows;

Sole Trader or Partnership Limited Company

You are the business.

The business is a separate legal entity.

Tax on profits
  • As a sole trader you would be classed as self-employed and taxed on all profits at income tax rates.
  • You would be subject to paying Class 2 & 4 National Insurance Contributions on your taxable profits as a sole trader.
  • The company pays corporation tax on its taxable profits at a current tax rate of 19%.
Extracting profits
  • Able to withdraw cash from the business at any time.
  • Money can be extracted from the company as earnings under a PAYE scheme and subject to National Insurance Contributions.
  • Extractions in the form of dividends are taxed on the effective dividend rates by the individual.
  • No requirement to prepare accounts for filing purposes.
  • You must prepare annual business accounts under the provisions of the Companies Act in accordance with Generally Accepted Accounting Standards.

Tax considerations

Due to the recent changes in dividend taxation, there is a narrowing of the tax advantages that trading as a limited company offers over a sole trader. This has resulted in the tax saving of a limited company being not as large to make the decision so clear-cut.

As a sole trader an individual must pay tax on all profits over and above their personal allowance. Once the personal allowance has been breached, tax is paid at the rate of 20% in the basic rate of tax 40% as a higher rate taxpayer and 45% in the additional rate band. As well as tax, sole traders also need to bear in mind Class 2 and Class 4 National Insurance Contributions.

A limited company, on the other hand, pays corporation tax on profits at a current rate of 19%, over and above this there may be personal tax liabilities in relation to dividend extractions from the business. In order for the extractions to be as tax efficient as possible the director would usually draw a small salary from the company within their personal allowance but not above the point at where national insurance becomes payable, this salary would be an allowable business cost for corporation tax. The remainder of their withdrawals would be in the form of dividends, these are paid out of post-tax profits and are not deductible expenses for corporation tax purposes so offer no tax saving, however there is no National Insurance Contributions to pay on dividends. There is no requirement for the owner to withdraw all profits from the business if they are not personally needed, and indeed it can prove tax efficient to leave profits retained in the company for extraction at a later date or to re-invest in the company.

The information in this article is believed to be factually correct at the time of writing and publication, but is not intended to constitute advice.  No liability is accepted for any loss howsoever arising as a result of the contents of this article. Specific advice should be sought before entering into, or refraining from entering into any transaction.