Having had to go through the process recently with a friend of deciding whether to set up as a Ltd company or trade as a sole trader for a new business venture that they weer setting up I thought it might be useful if I summarised the differences for anyone else in the same situation.
Ltd Company | Sole Trader |
| Financial Reporting | |
| Companies are governed by the Companies Acts. A company must: • Keep accurate and full accounting records • Produce audited accounts (if turnover is more than £5.6m) • File the accounts and an Annual Return with the Registrar of Companies. This information is available to the public upon request and payment of a small fee. • Keep Statutory Books. | Sole traders and partnerships are not required by law to have annual accounts nor to file accounts for inspection. However, annual accounts are necessary both to fill in an Inland Revenue tax return and as evidence of income and expenditure in the case of an enquiry by HMRC. |
| Personal liability and borrowing | |
| Companies may have greater borrowing potential. They can use current assets as security by creating a floating charge. It is possible to limit personal liability for company debts although many banks and other lenders may want to make directors personally liable for loans. | Sole traders and partners are unrestricted in the amount and purpose of borrowings but cannot create floating charges. All personal assets are at risk as the loan is given to the individual. |
| Selling the business | |
| Shares in a company are generally transferable – therefore ownership may change but the business continues. | This is not the case with sole traders and partnerships – if you are a sole trader you are the business, although you could “sell” the busines and let someone else service your customers for example. |
| Business credibility | |
| Incorporation does not guarantee reliability or respectability but gives the impression of a soundly based organisation. Some industries such as IT will only take on a freelancer if they are trading through a limited company. Some people think that there is a prestige attached to a directorship. | The unincorporated business does not seem to carry the same prestige to many people even though it may have traded longer than a limited company. |
| Taxation | |
| Tax is payable on director’s remuneration paid via PAYE on the 19th of the following month. There is both employer’s and employees’ national insurance payable on directors salaries and bonuses. The NI charge is greater than that paid by a sole trader/partner. You accountant should advise you on a tax-efficient remuneration strategy. If applicable, higher rate tax is paid by shareholders on dividends under the self-assessment rules. Corporation tax is payable 9 months after the year-end. For profits up to £300,000 Corporation tax is charged at 21% (2010/11). This will fall to 20% in 2011/12. | For a sole trader or partnership, profits are taxed at 20% on taxable income to £37,000, 40% on taxable income in excess of £37,000 and at 50% over £150,000 (2010/11). Tax is generally paid by instalments on the 31 January in the tax year and the 31 July following the tax year. A partner/sole trader will pay Class 2 NI of £2.40p.w. and Class 4 NI dependent on the level of profits. |
| Losses in a company can only be carried forward to set against future profits and you can not claim a refund on tax paid in previous years. | Any losses generated by a sole trader or a partner can be set against other income of the year or carried back to previous years. Businesses that expect to make tax losses in the early years need to consider this carefully particularly if the owner has paid higher-rate tax. |
As you can see, there are pros and cons for both methods of working but if you are unsure you should ask your accountant, if you do not have an accountant yet you might want to look at our page of accountants for small businesses or even look at this directory of local accountants.
Oh, and the friend in question decided to go down the route of sole trader for the moment with a view to starting a limited company in the future if they needed to, you can see their website by clicking here.