Every business enterprise, whether big or small must have a specific legal structure. Most of the businesses choose to be either a sole trader or a limited company. Both the structures are unique with their own advantages and disadvantages. The structure should be selected according to the functional requirements of the business. So what exactly is the difference between the two? And which structure could be more compatible with the business?
Let’s start with the basics and understand the difference.
What is a sole trader?
A sole trader is a self-employed person who is the owner of the business and conducts all the activities of the business. It is a very simple business structure and one of the most popular.
What is a limited company?
A limited company is a type of business structure that is a separate business entity, has its own legal identity, common seal and is independent of the workings of the shareholders and directors.
Now that the fundamental elements of both the structures have been discussed, the pros and cons of both have to be weighed against each other.
Sole trader advantages
- It is relatively easy to set up and requires less paperwork, other than an annual self-assessment tax return.
- A sole trader can freely run the business independent of the influence of others thereby making it easily maintainable.
- All the profits of the business go only to the sole trader and there is no sharing of profits.
- Minimal cost is charged if the business is required to be closed.
Sole trader disadvantages
- Sole traders have unlimited liability as they are not viewed as a separate entity. This means that if the business goes into debt the business owner is personally liable. Sole traders could lose personal assets if things go wrong in the business.
- Raising funds is a major challenge as banks and other investors tend to prefer giving financial aid to limited companies. This limits the expansion opportunities of sole traders.
- Tax rates are not always very kind to a sole trader. Once a sole trader reaches a certain level of earnings, it might not be profitable staying as a sole trader.
Limited company advantages
- A limited company has the advantage of limited liability as incorporation forms a legal distinction between the business owner and the business. This means that the personal assets of the owner will not be at risk if anything goes wrong in the business. Since limited companies get funds by selling shares to the public, shareholders are only liable to the extent of the value of their share in the company.
- Limited companies are more tax efficient than sole traders as they pay Corporation Tax instead of Income Tax. Corporation Tax is more reasonable which means the business stands to be more profitable.
- Once the name of the limited company has been registered, nobody else can use it. Sole traders do not get the same protection.
Limited company disadvantages
- Limited companies have more responsibilities as they have to conform to a strict code and cannot follow discretion. Going limited can be costly and time consuming. A lot of paperwork has to be adhered to.
- A limited company consists of many aspects and managing these different aspects is difficult. Because of this different competent professionals have to be employed for this purpose.
- The registration process is lengthy and time consuming.
There are some key differences that have to be kept in mind:
- Employment status: A sole trader is his own employer and cannot be his own employee. The director of a limited company is an office-holder and is treated as an employee of the company for Income Tax and Insurance purposes.
- Tax on profits: A sole trader has to pay Income Tax on the taxable profits of the business. The company pays corporation tax on its taxable profits. Shareholders are subject to income tax on dividends.
- Borrowing: A sole trader is free to borrow from the business bank account. If the business runs on an overdraft, tax relief on bank charges will be reduced. Borrowing by limited companies is permitted but there are limits and tax costs.
- Pension: A sole trader can avail a personal pension. In companies, the schemes offered are far more generous in terms of benefits and limits than a Personal Pension. However arrangements must be made for employee pension.
- Insolvency: If the business fails in case of a sole trader, the owner will be personally liable for the debts. In case of a limited company, the liability is restricted to the amount unpaid on the shares unless a personal guarantee is made for the company’s borrowing. A director can be made personally liable if he continues trading when the company is insolvent and this causes losses to creditors.
- Accounts: There is no requirement to keep accounts for tax purposes by a sole trader. However it is difficult to collect debts and work out profits without keeping accounts. A company must prepare annual accounts under the Companies Act and in accordance with accounting standards.
- Selling the business: In a sole trader, if the business or its assets are sold, the owner will be personally taxed on any gain under the Capital Gains Tax rules. In a company, if the business or its assets are sold, there is a double tax charge on the shareholders and the company has to pay Corporation tax on any profit it makes on asset disposal.
- Death: For a sole trader, the business ceases to exist on his death. Part or whole of the business can be inherited by the next generation. A company will continue to exist on the death of the director as it is a separate legal entity.
The decision regarding the business structure should be taken after carefully analyzing the above information. The structure chosen should be the best fit for the business. Consultation with professionals and technical experts will help make the process easier. If you have any query regarding Sole Trader Accounting Or Limited Company Accounting, Please get in touch with us.