Sole Trader vs Limited Company: Which Is Better for you?

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If you are starting a business in the UK, one of the first decisions you will need to make is whether to operate as a sole trader or set up a limited company. Both options can work well, but they are very different when it comes to tax, paperwork, legal responsibility and the way you take money from the business.

There is no single answer to the question of which structure is better, because the right choice depends on how much you expect to earn, the level of risk involved in your business, whether you plan to leave money in the business and how much administration you are prepared to deal with.

What is a sole trader?

A sole trader is the simplest way to run a business because there is no separate legal entity between you and the business. You own the business personally, make the decisions yourself and, after allowable business expenses and tax, the profits belong to you.

You can start trading as a sole trader without incorporating a company, although you may need to register for Self Assessment with HMRC. If your gross trading income is more than £1,000 in a tax year, you will normally need to submit a Self Assessment tax return.

One of the main advantages is simplicity. You generally have fewer formal filing requirements than a limited company, and your business accounts are normally dealt with through your personal Self Assessment tax return. You still need to keep proper records and calculate your taxable profit correctly, including claiming any allowable business expenses.

If you are new to self-employment, you may also find our guide on how to register as self-employed for the first time useful, particularly if you are unsure when you need to tell HMRC that you have started trading.

What is a limited company?

A limited company is a separate legal entity from its owners. This means the company itself owns its assets, enters into contracts and is responsible for its debts, rather than the business simply being an extension of you personally.

You can be the only shareholder and director of a limited company, so you do not need a large business or several employees before incorporation becomes possible. However, becoming a company director brings additional legal and accounting responsibilities.

A limited company normally pays Corporation Tax on its taxable profits, while you personally may pay tax when you take money from the company, for example through salary or dividends. This is one reason why simply comparing the Corporation Tax rate with the Income Tax rate can give you the wrong answer when deciding which structure is more tax efficient.

Which is easier to set up?

A sole trader is generally easier to set up because there is no need to incorporate a separate company with Companies House. You need to keep appropriate business records and deal with your tax obligations, but the structure itself is relatively straightforward.

A limited company involves more administration from the beginning. You need to incorporate the company, appoint directors, have shareholders, maintain company records and keep the company’s finances separate from your personal finances.

The company is also required to file accounts and other information with Companies House and deal with Corporation Tax and Company Tax Returns with HMRC.

Which has less paperwork?

If keeping administration to a minimum is important to you, being a sole trader will usually be simpler.

As a sole trader, your main annual tax reporting requirement will generally be your Self Assessment tax return, although you may have other obligations depending on your circumstances, such as VAT, PAYE, CIS or Making Tax Digital requirements.

A limited company has several separate responsibilities. The company needs to maintain accounting records, prepare statutory accounts, file information with Companies House and submit a Company Tax Return to HMRC. Directors remain legally responsible for ensuring that the company’s obligations are met even when an accountant is handling the day-to-day work.

Which structure gives you more protection from business debts?

This is one of the biggest differences between a sole trader and a limited company.

As a sole trader, there is no legal separation between you and your business. If the business has debts, you are personally responsible for them. This is known as unlimited liability.

With a limited company, the company is a separate legal entity and shareholders will generally have limited liability. This can provide an important layer of protection if the business gets into financial difficulty.

However, limited liability does not mean that a company director can never be personally responsible for anything. Personal guarantees, wrongful or fraudulent conduct and certain other circumstances can create personal liability, so you should not think of incorporation as complete protection from every business risk.

Is a limited company always more tax efficient?

No. This is one of the most common misconceptions when comparing the two structures.

A limited company pays Corporation Tax on its taxable profits, but the money belongs to the company rather than automatically belonging to you personally. If you want to take money out, you need to use an appropriate method such as salary, dividends or, in certain circumstances, a director’s loan. HMRC specifically recognises that directors need to follow rules when taking money out of a company.

A sole trader, on the other hand, is taxed personally on the taxable profits of the business. You do not have to pay yourself a salary or declare dividends because the business and you are legally the same person.

The tax calculation can therefore become quite different once you consider Income Tax, National Insurance, Corporation Tax, dividend taxation and the amount of profit you actually need to take out of the business.

This is why the question should not simply be “Which has the lower tax rate?” but rather “Which structure gives me the best overall result based on my profits and how I use the money?”

Can you leave profits in a limited company?

Yes, and this can be an important consideration.

If you do not need all of the company’s profits personally, a limited company can allow profits to remain inside the company after Corporation Tax. The money can potentially be used for working capital, future investment, equipment, expansion or other legitimate business purposes.

A sole trader does not have the same separation because the business profits are your profits personally, whether or not you physically transfer the money from the business bank account to your personal account.

This does not automatically make a limited company better, but retaining profits can be one factor that makes incorporation more attractive for some growing businesses.

What happens if you need all the business profits to live on?

If you expect to take practically all of the money generated by the business for your personal living costs, the tax advantage of a limited company may be smaller than you expect.

With a company, you generally have to consider how money is extracted from the company and the tax consequences of doing so. With a sole trader, the taxable profit is yours directly and there is no separate extraction process.

For this reason, a business making a particular level of profit can have a very different result depending on whether the owner needs to withdraw everything or can leave some money inside the business.

Which option is better for a small business?

For a small business with relatively straightforward activities, low commercial risk and an owner who wants to keep things simple, being a sole trader can be an excellent starting point.

For example, a freelance designer, cleaner, consultant, tradesperson or delivery driver may initially find that operating as a sole trader gives them everything they need without the additional administration of a company.

A limited company may become more attractive when the business grows, profits increase, the commercial risks become greater, customers expect to deal with a company, or the owner wants to retain profits in the business.

There is no requirement to start with a limited company simply because you hope the business will eventually become successful.

Does being a limited company make you look more professional?

Sometimes, but it should not be the main reason for incorporating.

Some customers and larger businesses prefer dealing with limited companies, and certain contracts or procurement processes may be easier to access through a company structure. However, being a sole trader does not mean that you are running an unprofessional business.

Your reputation, qualifications, customer service, pricing, insurance and quality of work are often much more important than the legal structure you have chosen.

Which is better for borrowing money or getting a mortgage?

Your business structure can affect how lenders look at your income, but being a limited company does not automatically make borrowing easier.

If you are self-employed, lenders may look at your business profits and tax returns, while directors of limited companies may be assessed using salary, dividends, company profits and other financial information depending on the lender’s criteria.

If you are self-employed and are thinking about applying for a mortgage, our guide on whether it is hard to get a mortgage when you are self-employed explains some of the issues lenders commonly consider.

What are the disadvantages of being a sole trader?

The biggest disadvantage is that you are personally responsible for the business.

If the business owes money, suffers a significant claim or becomes unable to pay its debts, your personal finances may potentially be affected. You also do not have the same separation between personal and business assets that exists with a limited company.

Another consideration is that as profits grow, personal tax and National Insurance can become a significant cost, although the actual tax position depends on your circumstances and the tax year involved.

There can also be situations where customers, investors or other businesses prefer to work with incorporated companies.

What are the disadvantages of a limited company?

The main disadvantage is additional administration.

A limited company has to keep proper company records, prepare statutory accounts and deal with Companies House filing requirements as well as Corporation Tax reporting. Private companies normally have to file annual accounts with Companies House within the applicable deadline, and the Company Tax Return has a separate HMRC deadline.

You also have to keep the company’s finances separate from your personal finances. You cannot simply treat the company bank account as your own bank account because the company is a separate legal entity.

There are also additional costs for accounting, payroll, company administration and professional advice, although the actual cost will depend on the complexity of the company and the services you use.

Can you change from sole trader to limited company later?

Yes. You do not have to make a permanent decision when you first start your business.

It is possible to start as a sole trader and incorporate later if the business grows or your circumstances change. GOV.UK also notes that it is usually easier to move from being a sole trader to a limited company than the other way around.

However, changing structure can have tax and legal consequences, particularly where you have business assets, property, goodwill, employees or significant profits, so it is sensible to plan the change rather than simply registering a company and assuming everything automatically moves across.

So, should you be a sole trader or a limited company?

For many people starting a small business, a sole trader is the simplest place to begin because it is straightforward, inexpensive to operate and involves less administration.

A limited company can make more sense where the business has greater financial or commercial risk, profits are sufficiently high to justify considering the different tax treatment, you want to retain profits in the company, or there are commercial reasons for operating through a company.

The important point is that there is no universal profit figure at which everyone should automatically incorporate. Your personal circumstances, other income, business expenses, expected profits, how much money you need to take out of the business and your plans for future growth all matter.

If you are considering incorporation mainly because you have heard that “limited companies pay less tax”, it is worth doing the numbers before making the decision. The structure that looks better on paper may not be better once all taxes, accounting costs and administrative requirements are taken into account.

For a broader look at the costs involved, you may also want to read our guide on how much accountants charge for small businesses in the UK, particularly if you are comparing the ongoing costs of operating as a sole trader with those of running a limited company.

Final thoughts

Choosing between a sole trader and a limited company is not simply a decision about tax. It is a decision about how you want your business to operate, how much responsibility you are prepared to take personally, how much administration you can manage and what you want to do with the profits.

If you are starting a relatively simple business and want to keep things straightforward, becoming a sole trader may be the most practical option. If you are building a larger business, taking on greater risks or planning to retain profits and reinvest them, a limited company may be worth considering.

The best structure is the one that fits your particular circumstances rather than the one that happens to be most popular or sounds most tax-efficient.

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