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Business 101: Sole Trader or Limited Company. Which is best?

Sole Trader or limited company? This is a question that vexes many business owners! Go to online forums, and you’ll see thousand of opinions! There’s no simple answer – there’s advantages with both structures. Although, as your business grows, you’ll probably want to set up a limited company.

In this guide, I’ll explain what each structure is. I’ll talk about the pros and cons of each structure. You can then decide what’s best for you.

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What is a Sole Trader?

A sole trader is the simplest and most popular business structure in the UK. It’s simply a self employed person, who’s the sole owner of the business. You can set up as a sole trader on this UK Government website. You need to report your profits on your personal tax return at the end of the year. You’ll pay income tax on those profits. Once you pay income tax on profits, you can do whatever you want with the money.

As the owner, you have unlimited liability. So you’re personally responsible for any debts that your business incurs – this is different to a limited company.

What is a Limited Company?

A limited company is an entirely different entity to the individual shareholders. The entity has limited liability. If it makes a loss, then the shareholders aren’t personally liable for those losses. Corporation tax is paid on profits (rather than income tax). Corporation tax is 19%, and the maximum income tax rate is 45%.

Once corporation tax is paid, then you can’t do what you want with the money. You can only use that money for business purposes. To use the money for your personal expenses, you must withdraw money from the company. I wrote an article on how to withdraw money from a limited company, and the tax costs.

A limited company needs to submit a separate tax return each year. Most companies get an accountant to do this. A company tax return costs a lot more than a personal tax return.

A limited company allows more flexibility with inheritance tax planning. It’s possible to gift your shares to your children or apply freezer shares strategies. These strategies aren’t possible for sole traders.

Section 24 for landlords

Section 24 is a tax that applies to buy to let properties, in your personal name. It says that you can’t deduct mortgage interest expenses for the calculation of tax. This tax only applies to properties owned in your own name, and not inside limited companies. The result of this rule has seen many property investors set up limited companies.

If you already own properties in your own name, you can transfer them to a company – tax free. You need to claim Section 162 Incorporation Relief. I explain how to do this in this article

I wrote a separate article that explains section 24, and how you can avoid this tax.

A word about partnerships

A partnership is a business entity between two or more individuals. A partnership needs to submit a separate partnership return each year. Unlike a limited company, you don’t have limited liability however.

Partnerships have become very interesting in recent years, for property investment businesses. If you structure your partnership correctly, it can be tax efficient to convert your property partnership into a limited company. Normally, you need to pay both Capital Gains Tax and Stamp Duty to incorporate your property portfolio. However, it can be possible to avoid both of these taxes, when you incorporate a property partnership.

I’ve also written a guide on the taxes that buy to let investors will face. It provides a nice summary.

Which is best for you?

So which structure is best for you? Well that answer depends on your circumstances.

Advantages of being a sole trader

  • Easier to set up
  • No need to produce a separate tax return
  • Once you pay income tax, you can do whatever you want with the profits

Advantages of having a limited company

  • Limited liability. The shareholders personal assets aren’t exposed. You can only lose the money you put into the company
  • You pay corporation tax, which is normally lower than income tax
  • You aren’t liable for Section 24. This is a tax that applies to properties owned in a sole tradership
  • More flexibility in relation to inheritance tax strategies

Sole Traders are best for

  • Smaller companies that don’t want to submit an extra tax return
  • Companies that don’t earn a lot of profits
  • Individuals that pay the basic rate of tax at 20%
  • Companies that don’t want to pay £1,000 per year (or more) on an accountant

Limited companies are best for

  • Individuals that pay tax at higher rate (40%) or additional rate (45%)
  • Large businesses with high profits
  • Property investors with a mortgage. Inside a company, you can fully deduct mortgage interest costs
  • Property investors with large portfolios, who want to avoid inheritance tax
  • Business owners that don’t want to expose their personal assets to their company

The correct corporate structure is a question that vexes many entrepreneurs. Sole trader or limited company? In this article, I’ve explained what each structure is. I’ve also discussed the advantages and disadvantages of each structure. This should enable you to decide what is best for your business. 

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