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Sole trader or limited company – What is the difference?
Most HR practices choose to be either a sole trader or a limited company but what is the difference between the two and how do they compare?
No matter how big or small, your business needs a legal structure. You can choose from sole trader, limited company or partnership. Most choose either of the former two.
According to the National Statistics Business population at the start of 2021, there were 3.2 million sole proprietorships (56% of the total), 2.0 million actively trading companies (37%) and 384,000 ordinary partnerships (7%).
What is a sole trader?
A sole trader is where you are the sole owner of your business and you’re self-employed. It is the simplest business structure which could be the reason it is the most popular. You can set up as a sole trader via the government website. You are required to do so for tax purposes.
What is a limited company?
A limited company has its own legal identity. It is separate from the business owners, the shareholders. This remains even when it is one person acting as shareholder and director of a company running it.
Sole trader vs limited company
So, what are the advantages and disadvantages of the two business structures?
Some of the key differences between the two are you can easily set up as a sole trader. You just need to inform HMRC you’re self-employed and pay tax through Self-Assessment. The law does not see you as the sole trader separate from your business. Therefore, as a sole trader, you are personally liable if your business runs into debt.
On the other hand, a limited company has a separate legal identity from its owners. Which means you only lose what you put into the company; this reflects the name ‘limited’. Your personal assets are not liable should things go wrong. However, a limited company face more rules and responsibilities than sole traders. This makes running one more time-consuming and costly.
Each form of legal structure has its own pros and cons. It is your decision to weigh up what’s best for you and your business. Seek expert advice from an accountant who can provide invaluable advice around tax.
Sole trader pros and cons
- Being a sole trader is more straightforward and easier to set up. It doesn’t have too much paperwork either, other than your annual Self-Assessment tax return.
- As a sole trader, you will have greater privacy than incorporated businesses. Director details are published on Companies House.
- As a sole trader you have no legal separation from the business. This means you have unlimited liability. So, if your business runs into debt, you are personally liable for it.
- If things go wrong, you as the sole trader can lose personal assets.
- Banks and investors tend to prefer limited companies. This makes raising finance tricky. Hence limits expansion opportunities.
- Limited companies are more tax efficient than sole traders. Therefore, it may be worth considering a limited company when your earnings reach a certain level.
Limited company pros and cons
- A limited company has a separate legal identity from its business owners. Unlike sole traders’ liability is therefore limited.
- Because liability is limited it means your personal assets are protected.
- Once you’ve registered a company name, it’s unique to you and can’t be used by another party.
- Limited companies tend to benefit from tax efficiency. Instead of paying income tax, they pay corporation tax. It is best to speak to an accountant and get expert advice on this.
- Limited companies have more responsibilities known as the director’s fiduciary responsibilities.
- The added responsibilities and extra paperwork make it more time-consuming to run a limited company.
- Information about your business and you as a director of the company are available on Companies House. So, your details and your company earnings will be publicly available.
- Unlike a sole trader where there are no fees to set up. You will need to pay a fee to incorporate.
Thinking of starting your own HR practice? Check out our “Setting up your own HR practice: Your checklist”.
Author: Mary Asante, Director | HRi