Sole trader versus limited company: what’s best for your new business?

A new year and the onset of spring is often a time when people decide to bite the bullet and set up a new business.

If you’re among them, then one early decision you’ll need to make is whether to become a sole trader or set up a limited company. 

There’s certainly no one-size-fits-all answer, because each carries its own advantages and disadvantages. If you’re wondering which way to jump, this might help you decide: 

Advantages of being sole trader 

Firstly, there are fewer admin costs to being a sole trader. In a nutshell, it is cheaper and easier. Contracts with clients just have to be in the individual’s name, not the company name and accounting is more straightforward. 

Secondly, if the cost of a car is to be put through the business, sole trader status is more flexible. This is because here, the car cost carries no benefit in kind. Generally, tax which is incurred for putting a car through a limited company will be higher. However, there is an exception; if you have an electric car through a limited company this will be cheaper. 

Finally, financial information does not need to be made public. If you’re a sole trader, there is no requirement to register with Companies House and submit annual accounts, that anyone can view. This may or may not be important to you. You may want to keep your financial information confidential, or you may be happy for public scrutiny. It is something to consider. 

Advantages of being a limited company director  

As a limited company director, you are more in control of your taxes. When you are a sole trader, you are taxed on the profits you make regardless of whether you spend the money or not, outside the business. If you make £100,000 profit, but only spend £25,000 with the rest sitting in a savings account, you are still taxed on £100,000. In this example, this pushes you easily into the higher rate tax bracket, and (if you’re a parent) you’ll no longer be able to take advantage of child benefit. 

The situation is very different if you run a limited company. Here, you are taxed personally only on the dividend or salary you draw. In our example, if you make £100,000 profit you only pay 19% Corporation Tax and personally pay tax on the £25,000 you take out of the business. These rates are going up from 1 April 2023 and the percentage charged will be based on the level of profits. A company making more than £250,000 in taxable profits will pay 25% Corporation Tax. 

Secondly, there is less risk in a limited company. If you have customers who don’t pay, and you can’t then pay your suppliers, then it is your limited company which is liable, not you personally. The company may go into administration, but your personal assets should be unaffected. 

By contrast, as a sole trader, if you fall into debt with suppliers and court action ensues, you are personally liable. If yours is a business that doesn’t have lines of credit, you have minimal risk. If, however, you have creditors – for example, you are a builder and need income to pay for your building material suppliers and sub-contractors – then the risk is higher. 

Thirdly, perception may be a consideration. Depending on your type of business, there may be an advantage to running a limited company, in terms of how you are regarded by others. Some businesses may not want to deal with a sole trader, or they may assume you are too small.  

Equally, you may have a limited company which has minimal turnover – and we deal with limited companies whose turnover is as low as £9,000 – but the assumption is that they are larger, and this might open doors to new clients. Whether or not this factor is an advantage, really depends on how you want to position yourself. 

Finally, you might want to consider access to tax credits. Some tax credits, such as R&D, are only available for limited companies. This is an area well worth exploring if you are planning to invest, because R&D covers a wide area. Among our clients are IT specialists who have created new software, and another making new-to-market tools. 

Similarly, the Super Deduction Scheme for investing in qualifying new plant and machinery assets is was only available to companies, this scheme introduced by Rishi Sunak during the pandemic comes to close on 31 March 2023. 

At Optimum, when we work with clients, we talk through all the options and help them decide the best business model to suit their particular circumstances. If you are setting up in business, please get in touch with me, Michael Blaken, Accounts Director at Optimum. 

More information on Optimum Professional Services here.