When starting a small business, one of the first things to decide is the legal structure – Sole Trader, Limited Company or a Partnership. We are going to focus on the first two.
Setting up as a sole trader is the most popular legal structure in the UK, with approximately 3.5 million sole proprietorships in 2019. Sole traders accounted for 60% of small businesses in the UK. There were also 1.9 million limited companies, making it the second most popular legal structure.
Sole trader or limited company
Even though sole traders are the most popular option for the small business owner, there are clear benefits and advantages of having a limited company over becoming a sole trader.
Here is why a limited company structure may be better for you than becoming a sole trader.
Limited liability
One of the biggest benefits of having a limited company structure instead of operating as a sole trader is that with a limited company you have limited liability.
As a sole trader, the business owner and the business are treated as one entity. Whereas, with a limited company the business itself is a separate entity in the eyes of the law. If you have business debts as a sole trader your personal finances and assets are in danger. This is because legally there is no difference between your assets and the business’ assets.
As well as your finances, you will need to keep in mind any legal disputes. If you are a sole trader then you will need to make sure that you have various different small business insurance policies in place to avoid getting sued personally. As in the eyes of the law, you and your business are the same, without insurance, you will be sued personally. Another benefit of having a limited company is that you won’t be personally sued as the company is a separate entity.
Tax
Another very prominent advantage a limited company has over sole traders is that they can be more tax efficient.
This is because a limited company has its own tax (Corporation Tax) at 19% and the shareholder, generally, will only pay tax on their dividends, whereas a sole trader will have to pay tax on all of the profits that are above their personal tax allowance (£12,500 for the tax year 2020/21).
If you are a low earning business of below £20,000, operating as a sole trader is potentially more tax efficient system.
Annual accounts
The main disadvantage of a limited structure compared to a sole trader is that, as a limited company owner, you have far more filing responsibilities at HMRC and Companies House. These consist of full accounts filed at HMRC, filleted accounts at Companies House, a Corporation Tax Return at HMRC, Annual Confirmation Statement at Companies House, payroll submissions, and a self assessment tax return for the Directors.
As a sole trader, a self assessment tax return is the only filing requirement.
Perception
From the outside looking in, a limited company can look more established, more professional and be more attractive to other businesses to work with.
This again links back to the limited liability of a limited company. Businesses, contractors, clients etc. are more likely to work with a limited company as their perception is that a limited company is more professional.
Conclusion
A sole trader legal structure for your business is the easiest to set up and that’s why it has been proven to be such a popular option.
However, there are clear advantages to running your business through a limited company structure.
Before making a decision, it’s important that all factors are considered. Speak to a professional and make your decision based on facts and a proper understand of what is involved.
