Sole Trader vs Limited Company: Which Is Right for You?
When starting a business in the UK, one of the first and most important decisions you’ll face is whether to operate as a sole trader or to form a limited company. Each structure has distinct implications for liability, taxation, compliance, and how you extract profits. This article outlines the key differences to help you decide which is best for your needs.
Legal Status and Liability
Sole Trader
You are the business. Legally, there is no distinction between you and your business. This means you are personally responsible for any debts or legal claims made against your business.
Limited Company
A company is a separate legal entity. In the event of a legal dispute, the company will be sued not it’s owners. Your personal liability is usually limited to the value of your shares, unless you have given personal guarantees or acted illegally.
Taxation
Sole Trader
You need to pay Income Tax and Class 4 National Insurance on your business profits. Losses may be offset against other personal income, which can provide useful tax relief.
Limited Company
Companies pay Corporation Tax on profits. As a director/shareholder, you may receive a salary (subject to PAYE and NICs) and dividends (subject to Dividend Tax). While Corporation Tax rates can be more favourable than higher rates of Income Tax, extracting profits may result in additional tax charges.
Profit Extraction
Sole Trader
You can withdraw funds freely without triggering additional tax your profits are taxed as they arise.
Limited Company
Withdrawing funds can be more complex. You can pay extract money via salary, dividends, or director’s loans, each with its own tax considerations.
Compliance and Administration
Sole Trader
Limited Company
Pensions
Sole Trader
You can contribute to a personal pension.
Limited Company
The company can contribute to your pension which can be a tax efficient method of extracting money from the company.
Insolvency
Sole Trader
You’re personally liable for all business debts. Failure can result in personal bankruptcy.
Limited Company
Your liability is limited. However, directors may be held personally accountable if they continue trading while the company is insolvent or act negligently.
Selling
Sole Trader
When the business or assets are sold, you are taxed personally on any gains under the Capital Gains Tax (CGT) rules. A disposal may qualify for Business Asset Disposal Relief (formerly Entrepreneurs’ Relief).
Limited Company
When business assets are disposed of, the company will pay corporation tax on any gains. On the sale of shares in the business, the shareholders will be taxed under the CGT rules on any gain. The disposal A disposal may qualify for Business Asset Disposal Relief.