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Start-up series: Sole trader vs. Limited company

Welcome to the second blog in our series on starting up a business, you can read last week’s introductory blog here. In this weeks blog we would like to introduce you to two of the main business structures for small business start ups – sole trader and limited company – along with the pros and cons of each.

What is the difference?

If you are registered as a sole trader, in law, there is no distinction between you and the business. Therefore you will be personally liable for any business debts and this can place personal assets, such as your home or car, at risk if the business fails. As a sole trader you would be classed as self employed and would be required to file a Self Assessment Tax Return and make payment for Income Tax and National Insurance yourself.

Another option is to set up a private limited company, of which you would become a director and shareholder. The limited company is a legally separate entity to yourself. Therefore, providing you don’t trade fraudulently, recklessly or give personal guarantees for loans, the risk of loss is restricted to your investment in the company and any personal cash you invest. Setting up a limited company can be done online relatively quickly for just £12, or £40 if registering by post.

Tax Implications

The basis of taxation and therefore the amount of tax paid are likely to be different for sole traders and limited companies. Sole traders are self employed and are required to pay income tax on business profits at the basic, higher and additional rates depending on income. If you earn profits of over £6,365 you must also pay Class 2 National Insurance contributions (NICs) of £3 a week. Additionally if your profits are over £8,632 you will pay Class 4 NICs which is calculated on a percentage of profits.

Limited companies are required to submit a Corporation Tax Return each year and pay Corporation Tax at 19% of profits less allowances and reliefs. Company directors are classed as employees and will pay Income Tax and NICs via PAYE on their salary. Dividend payments are often paid to company directors, tax is not paid on the first £2,000 but amounts over this are subject to income tax. The amount of income tax due will depend on which tax band you are in.

Depending on the structure of your business you may find one business type is more tax-efficient for you than another.

Other matters to consider

A Limited company has the added benefit of limited liability should the business run into financial trouble. Additionally some feel that customers and suppliers may perceive limited companies as more stable and professional. Alternatively running as a sole trader gives you greater control over the business, as you would not have shareholders to report to. You may choose to initially run your business as a sole trader and register as a limited company at a later date as your business grows.

What should I do?

There are advantages and disadvantages to both types of business structures. There are variations on these scenarios. One alternative is that you could go into partnership with one or more other people in which case the partners are all self employed. There is no one business structure that is best for all businesses. There are a number of factors to consider including administration, control, taxation and future plans. We would recommend sitting down with your accountant and discussing all of the potential business structures in depth and what this means for your specific circumstances before making a decision. Your accountant can provide advice including which is likely to be the most tax-efficient structure for your new business.

DNG Start up series

Keep visiting our website over the coming weeks for more blogs to help you if you have started a new business or are thinking of doing so. These will include taxes small businesses are required to pay, record keeping, the benefits of a good accountant and more. For any advice regarding the topics we cover please contact us and we will be happy to help you and your business to grow and thrive.

Ian Lowry



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