When you decide to start your own business, one of the first big decisions most entrepreneurs face is deciding whether to register as a sole trader or as a limited company. Choosing the right legal structure for your new start-up can affect how tax efficient you are as a business, so it’s a big decision.

There are pros and cons of any type of business structure, so deciding which one is best for you really depends on your particular circumstances. To help you choose, we explain the differences between operating as a sole trader versus as a limited company.

What’s the difference between a sole trader and a limited company?

One of the key differences is that setting up your own limited company means the business is a separate legal entity to you as the owner, and any money the business makes belongs to the company. On the other hand, if you decide to register as a sole trader then you and the business are legally the same, and there’s no legal distinction between you.

This idea of the legal relationship between you and your business is absolutely crucial. It impacts your obligations as a business owner, reporting requirements, how you pay tax as a business, and even how you pay yourself or claim expenses.

What am I liable for as a sole trader versus as a company?

As a sole trader there’s no legal distinction between you and your business so you’re personally liable for what happens legally and financially. And yes, this includes any debts! This could result in you losing your personal assets if the business runs into problems.

Some industries are more financially risky than others, such as those where the business needs to up-front larger sums of money before getting paid by the client, so these might not be best suited to operating as sole traders.

The ‘limited’ part of limited company refers to the way that personal liability is limited. It offers more protection to the directors and shareholders in the business, with any debts being the company’s liability, and not yours personally.

How do I pay myself as a sole trader compared to a limited company?

As far as HMRC are concerned sole traders and their business are the same thing, so they can keep all of the after-tax profits that the business makes. If you operate as a limited company you’re a completely separate entity to it, so any profits belong to the business.

Obviously you want to make money from your business, so you’ll need a more formal arrangement to pay yourself from the company – usually using a combination of a salary and dividend payments.
 

Tax efficiency for sole traders and limited companies

The way that you pay yourself as a sole trader or as a limited company has an impact on how tax efficient you are. Because there’s no legal separation between sole traders’ personal finances and those of the business, you’ll pay Income Tax on your profits whether or not you actually use them personally.

In a limited company the profits stay in the business until you pay them to yourself. You could pay yourself a tax efficient salary as a company director, and you’ll pay tax and National Insurance on it once you reach the thresholds for these. Just remember that employers pay National Insurance as well as employees, so if you cross the NI threshold you might end up paying twice on the same money.

If you’re also a shareholder, you can pay yourself a smaller salary (lower than the tax and National Insurance threshold), and then take the rest of your income as a dividend. A dividend is a payment made to a shareholder from the company’s profits after tax, and they’re not subject to National Insurance. You’ll still need to pay tax on your dividend income, but Dividend Tax starts at a much lower rate than Income Tax.

Is being a sole trader more private than being a limited company?

In a way, yes! As a sole trader you can run your business with no requirement to make information available to the public. Limited companies must register with Companies House, and this information is published online.

You do have the option of using a registered office address to protect your private one, but your name and annual accounts will be publicly available through Companies House, who publish them online. It’s something to keep in mind if you’re running a side hustle and don’t want your boss to know!

Reporting obligations and deadlines for sole traders and limited companies

You’ll need to keep detailed records of the business’s financial activity whichever structure you choose, though being a sole trader usually means there is slightly less admin than there is if you run a limited company.

Sole traders pay Income Tax and National Insurance on their profits by submitting a Self Assessment tax return to HMRC.

In a limited company there’s a bit more to do, so you’ll need to submit a Company Tax Return for the business, as well as submitting accounts to Companies House. You’ll normally also need to report the personal income that you take from the company, such as submitting a Self Assessment tax return to report any dividends.
 

Registering your new business

The way you register your business is a bit different depending on whether you decide to become a sole trader or operate as a company.

Registering your business as a sole trader

Sole traders register by signing up for Self Assessment with HMRC. The deadline for a sole trader to register for Self Assessment is 5^th October in the business’ second tax year.

Incorporating a limited company

Setting up your business as a limited company has a slightly different process to becoming a sole trader. You’ll need to register the business with Companies House, which will automatically enrol you for Corporation Tax with HMRC.

There’s quite a bit more paperwork involved to get started, such as appointing directors and shareholders, and preparing documents setting out how the company will be run. There’s also a fee for registering, unlike sole trader businesses which are free to register.
 

Choosing the right legal structure for your new business

How you decide to operate your business depends on you, but there are a few points to consider:

• Is your profit figure around £30,000 or more?
• Is this a high-risk business in terms of potential liability, such as dealing with the public a lot, or large transactions?
• Do you have an income from another job?

It’s not cast-iron, but answering yes to any of these can indicate that registering as a limited company might be more beneficial than becoming a sole trader. This is because the level of income suggests that incorporating a company is likely to be more tax efficient for you, but it’s important to remember everyone’s different, so it’s worth taking advice first if you have any questions.

 
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