Choosing Between a Limited Company or a Sole Trader
When you are starting out in Business, there are lots of exciting and difficult decisions to make. Choosing the best type of business vehicle for you is one of the most important.
This article will show you the advantages and dis-advatages of the different options available.
We have a follow-up article, "Setting up a Limited Company", which shows you step by step how form your own Limited Company.
What is a Limited Company?
In the eyes the Law, a Limited Company (Ltd Co) is a completely seperate legal entity, that is owned by its Shareholders, and controlled by its Directors. In its simplest form, the Director and Shareholder will be the same person.
The Ltd Co should have its own bank account, to keep the money seperate from that of the Director's.
One of the most important things to remember about a Ltd Co, is that the money that it makes DOES NOT belong to the Director. The only way that money can be taken out of the Ltd Co is by either a Salary or a Dividend.
There are severe penalties for Directors who take money out of the Ltd Co without either a Salary or a Dividend. This is one of the most common errors that Directors/Shareholders make. The money will need to be paid back to the Ltd Co, and you also pay 25% of the amount in tax. This is known as a Directors Loan Account, and it is highly recommended to be avoided.
Director's Responsibilites
A major advantage of trading through a Ltd Co, is that as the Ltd Co is a seperate entity, the debt's of the Ltd Co are seperate from the Shareholder's. This means that as a Shareholder, you only risk the amount of your initial investment, and your own personal assets - such as your house or car - cannot be used to pay off debts of the Ltd Co.
However, Directors do have responsibilities to always act in the best interest of the Ltd Co. These are known as Fiduciary Duties. A Director can be breaking the law, and sent to prison, if he/she knowingly incurs debts that cannot be paid.
The Directors must ensure that accurate accounting records are kept. Using the right accountant for your business is essential. See our guide on choosing your accountant.
All of the details of the Ltd Co, including the home address of its Directors, is available to the general public, via Companies House.
Tax Advantages
Another of the main reasons for trading through Ltd Co, is that the profits it makes are taxed a lower rate than compared to a Sole Trader. Dividends are also a very tax efficient method of recieving payment from the Ltd Co. So with careful tax planning, substantial savings can be made in your tax bill when compared to a Sole Trader. You will, however, require the services of a friendly accountant to help with computing your tax, paying dividends and making the most of your Ltd Co. Find your new Accountant here.
Use my handy widget below to see just how much better off you are by trading through a Ltd Co compared to a Sole Trader.
This article will show you the advantages and dis-advatages of the different options available.
We have a follow-up article, "Setting up a Limited Company", which shows you step by step how form your own Limited Company.
What is a Limited Company?
In the eyes the Law, a Limited Company (Ltd Co) is a completely seperate legal entity, that is owned by its Shareholders, and controlled by its Directors. In its simplest form, the Director and Shareholder will be the same person.
The Ltd Co should have its own bank account, to keep the money seperate from that of the Director's.
One of the most important things to remember about a Ltd Co, is that the money that it makes DOES NOT belong to the Director. The only way that money can be taken out of the Ltd Co is by either a Salary or a Dividend.
There are severe penalties for Directors who take money out of the Ltd Co without either a Salary or a Dividend. This is one of the most common errors that Directors/Shareholders make. The money will need to be paid back to the Ltd Co, and you also pay 25% of the amount in tax. This is known as a Directors Loan Account, and it is highly recommended to be avoided.
Director's Responsibilites
A major advantage of trading through a Ltd Co, is that as the Ltd Co is a seperate entity, the debt's of the Ltd Co are seperate from the Shareholder's. This means that as a Shareholder, you only risk the amount of your initial investment, and your own personal assets - such as your house or car - cannot be used to pay off debts of the Ltd Co.
However, Directors do have responsibilities to always act in the best interest of the Ltd Co. These are known as Fiduciary Duties. A Director can be breaking the law, and sent to prison, if he/she knowingly incurs debts that cannot be paid.
The Directors must ensure that accurate accounting records are kept. Using the right accountant for your business is essential. See our guide on choosing your accountant.
All of the details of the Ltd Co, including the home address of its Directors, is available to the general public, via Companies House.
Tax Advantages
Another of the main reasons for trading through Ltd Co, is that the profits it makes are taxed a lower rate than compared to a Sole Trader. Dividends are also a very tax efficient method of recieving payment from the Ltd Co. So with careful tax planning, substantial savings can be made in your tax bill when compared to a Sole Trader. You will, however, require the services of a friendly accountant to help with computing your tax, paying dividends and making the most of your Ltd Co. Find your new Accountant here.
Use my handy widget below to see just how much better off you are by trading through a Ltd Co compared to a Sole Trader.
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Prestige, Status and Image
Being a Ltd Co can help when it comes to obtaining work. Potential customers might feel more confident that a Ltd Co is more official, and therefore more trustworthy, than a Sole Trader. In fact, some larger companies will only deal with Ltd Co's.
Sole Trader
Working as a sole trader, also known as being Self Employed, is when an individual person does work for another person or organisation on a temporary basis. It is sometimes difficult to distinguish between a Sole Trader and an Employee, so HMRC have devised certain tests that can identify which category someone is.
Factors such as:
-Do they provide their own equipment?
-Can they send alternative people to perform the tasks?
-If work is sub-standard, does the sole trader repair the work at his own cost?
Answering yes to the above questions would indicate that the person is a Sole Trader, rather than an employee.
National Insurance & Income Tax
A major advantage of being self employed is that they pay a lot less National Insurance, when compared to an employee who receives a salary.
There are also a lot more allowances available, such as Capital Allowances, that can be used to offset your tax liability. Again, you will need to talk to your Accountant about your specific circumstances.
Administrative Burdon
Compared to operating a Ltd Co, there are a lot less obligations to fulfil. You don’t need to file accounts at Companies House, you don't have to put all of your personal details on public display, no dividends to worry about, no shareholders to please. However, you do need to file a Self Assessment Tax Return each year, and there are penalties for filing it late.
Summary
As discussed above, there are many advantages in choosing either option of running your business. The Self-Employed route is by far the easiest method, but it can lack that air of professionalism that a Ltd Co brings with it.
At first glance, running a Ltd Co may seem like a big responsibility, but in reality, if you are well organised and are aware of your obligations, it really is very simple. Most importantly, get yourself a brilliant accountant who can talk you through the process in the early days.
Being a Ltd Co can help when it comes to obtaining work. Potential customers might feel more confident that a Ltd Co is more official, and therefore more trustworthy, than a Sole Trader. In fact, some larger companies will only deal with Ltd Co's.
Sole Trader
Working as a sole trader, also known as being Self Employed, is when an individual person does work for another person or organisation on a temporary basis. It is sometimes difficult to distinguish between a Sole Trader and an Employee, so HMRC have devised certain tests that can identify which category someone is.
Factors such as:
-Do they provide their own equipment?
-Can they send alternative people to perform the tasks?
-If work is sub-standard, does the sole trader repair the work at his own cost?
Answering yes to the above questions would indicate that the person is a Sole Trader, rather than an employee.
National Insurance & Income Tax
A major advantage of being self employed is that they pay a lot less National Insurance, when compared to an employee who receives a salary.
There are also a lot more allowances available, such as Capital Allowances, that can be used to offset your tax liability. Again, you will need to talk to your Accountant about your specific circumstances.
Administrative Burdon
Compared to operating a Ltd Co, there are a lot less obligations to fulfil. You don’t need to file accounts at Companies House, you don't have to put all of your personal details on public display, no dividends to worry about, no shareholders to please. However, you do need to file a Self Assessment Tax Return each year, and there are penalties for filing it late.
Summary
As discussed above, there are many advantages in choosing either option of running your business. The Self-Employed route is by far the easiest method, but it can lack that air of professionalism that a Ltd Co brings with it.
At first glance, running a Ltd Co may seem like a big responsibility, but in reality, if you are well organised and are aware of your obligations, it really is very simple. Most importantly, get yourself a brilliant accountant who can talk you through the process in the early days.
