Limited company vs Sole trader

Dec 11, 2022

Written by Greg Hanton. Greg is co-founder of Joy Pilot, No Worries Accounting, No Worries Red Umbrella, and Capital City Accountancy. He has over two decades of experience in providing tax and accounting support to contractors, especially those working in the UK. Greg holds a BE (Hons) in Chemical & Process Engineering from the University of Canterbury and a BSc in Chemistry from the University of Otago. He is also a Chartered Accountant (ACCA), member of AAT, and a Chartered Engineer (IChemE). With a passion for innovation and client-focused solutions, Greg continues to lead the charge in transforming the accounting landscape. See more on LinkedIn.

Updated on: Feb 19, 2024

As a specialist contractor accountant, most of our clients contract using their own limited company, however we do also have a number of clients who choose to work through a sole trader structure. Here, I just wanted to take a look at the main differences between the limited company vs sole trader trading structures to help new contractors decide the best option for them, and also for existing contractors to consider if they’re still using an appropriate structure for their own business.

Can I Work as a Sole Trader?

The most important consideration in the ltd company vs sole trader debate is to determine if you have a choice over the business structure you can use. Most of our limited company contractor clients are required to use a limited company and so often the decision is made for them by the recruitment business or end client they are working for.

There are three common reasons for this but the most significant relates to the agency tax rules (ss.44-47 ITEPA) which state that where recruitment businesses supply individuals, they are responsible for paying income tax and national insurance on the payment that the sole trader receives for the work performed. If the sole trader does not declare their income fully, or just “disappears” then the recruitment business will be responsible for paying their tax bills of their behalf.

As you can imagine, recruitment businesses will avoid this kind of risk by simply not engaging workers as sole traders.

Taxes

Limited Company

There are a variety of taxes to be paid when working through a limited company. The three most common are corporation tax, VAT (including the flat rate VAT scheme), and personal tax although some clients may also have PAYE and National Insurance contributions to make on salary.

The calculation of these taxes and the due date for payment increases the administrative load on the contractor. However, there are more opportunities for saving tax when working through a limited company. The most common two are;

(a) income smoothing where you don’t necessarily pay yourself all of your profits but rather retain them in the business for periods where you may not be working, and

(b) when you come to close down your company there are tax efficient methods to extract funds from your business.

Sole trader

Do sole traders pay corporation tax? No, the taxation of a sole trader business is much simpler. At the end of the tax year your business profit is calculated on your self-assessment tax return and any taxes due must be paid by the 31st of January following the end of the tax year. If you are VAT registered you will also need to make your quarterly VAT payments.

While there are benefits in simplicity, the tax saving opportunities mentioned above for limited companies do not exist.

Liability

Limited Company

When you work through a limited company, your liability is protected because the company is a separate legal entity. This legal structure means that the company is responsible for its own debts, not you as an individual. Your liability is limited to the amount of money you have invested in the company, meaning you can’t be held personally responsible for any debts or losses incurred by the business. Because the company has its own legal identity, this helps to protect your personal assets, such as your bank accounts, vehicles, and property.

Sole trader

Your liability is unlimited because you are personally liable for any debts or losses that your business incurs. This means that any legal action taken against the business can be extended to you, as the sole trader, and you can be held liable for any losses that the business may incur. Furthermore, all assets that you own, such as bank accounts, vehicles, and property, can be taken to cover any damages or debts that the business has, which reinforces the concept of unlimited liability for a sole trader.

Costs and Administrative Workload

Limited Company

You are responsible for a range of costs and extra workload when working through your own limited company. Firstly, you will need to pay company registration fees to Companies House, open a business bank account, and ensure you submit accounts and confirmation statements annually to Companies House. In addition to this, annual accounts and a company tax return must be filed each year with the HMRC, and it must also pay corporation tax each year. This paperwork must be submitted by a certain deadline each year and failure to do so can result in late filing penalties.

Additionally, you will need to factor in the costs associated with running a limited company such as accountancy fees to help keep on top of things. And you have to deal with administrative work such as recording all your business transactions, approving accounts for filing, and tracking your company profitability to ensure you have enough profits to take dividends. At No Worries we help with all these things as part of our normal accounting service.

Sole Trader

Here you are also responsible for administrative work such as recording all your business transactions, however the reporting requirements for a sole trader are much simpler. You only need to file a single personal tax return every year to report your business income to the HMRC, and the reporting date and tax due date are both 31st of January following the end of the tax year.

Summary of Limited company vs Sole Trader

The three main considerations related to sole trader vs limited company relate to taxes, limited liability, and costs/administrative workload. Generally speaking, the additional cost of running a limited company and the administrative workload is offset by the additional tax planning opportunities you have when working through a limited company. However, this form of working is not for everyone and requires a certain element of organization to ensure the limited company is operating compliantly and the most tax efficient way. In both cases we highly recommend the trading entity has its own company bank account.

Man sitting at company thinking about his limited company vs sole trader options for his new design company.

We specialise in providing accounting services for contractors that significantly eases the burden of running your own limited company and are happy to help you with any questions along the way, especially if you are looking at your sole trader v ltd company options. Take a look at our other resources including information on tax liability issues such as paying tax on dividends, how corporation tax works, and tax planning for limited company contractors.

One thing we have not mentioned here is working through an Umbrella company. This form of contracting is typically used where the work is sourced through and agency and is caught by IR35. We can also help with this using our Umbrella service.

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