Operating as a limited company is one of the most popular businesses for all sizes and types of businesses. In order to register a company in the UK, The business must be incorporated legally with the Companies House. Companies House is a government agency which is sponsored by the Department of Business, Innovation and Skills. It operates as the official registrar of the companies in Wales, England, Northern Ireland and Scotland.
When a limited company is incorporated, it is considered a separate individual by the law. A limited company is responsible for its own liabilities and debts. The company has to disclose some corporate information on public records. Companies must also adhere to different reporting and filing requirement according to the Companies Act of 2006. They also have to pay 20% Corporation tax on their taxable income.
Both a for-profit company that is limited by shares and a non-profit company that is limited by guarantee enjoy many benefits which are not available to the sole traders. Operating as a sole trader is also a very popular structure for businesses of small and medium-size. In fact, it is the 2nd most popular type of business structure in the UK.
In a sole trader structure of the business, the business is owned and operated by the same individual and he is himself liable for all the claims and debts. The person is also responsible for paying National Insurance Contributions and Income tax return on all the taxable income. The person has to file Self-Assessment tax return each year. There is no legal distinction between a person operating as a sole trader and his business.
The major differences between the two types of structures are tax efficiency, professional status required administrative and filing responsibilities and financial liability. One should consider these factors carefully in order to determine which legal structure will give the most benefits to the business and the owner.
One or more people, called members are the owners of the private limited companies. The members of those companies which are limited by shares are referred to as ‘shareholders’. On the other hand members of those companies which are limited by guarantee are referred to as ‘guarantors’. The directors are responsible for managing both types of companies.
However, a large number of small companies are managed and owned by only one person who takes care of the roles of guarantor/shareholder as well as a director. A limited company has a flexible nature, giving and opportunity to set up companies with multiple directors and members and an opportunity to appoint new people after formation.
Advantages of operating as a limited company
The three main reasons for trading as a limited company are status, tax efficiency and limited liability.
- Limited Liability: It is the biggest benefit of running your business as a limited company. In case the company goes into financial difficulty, the assets and personal finances of shareholders are protected beyond the value of their shareholding. This means that if a company is unable to pay debts, the shareholder will only have to contribute according to the nominal value of their shareholding. It can be as small as £ 1.
If you want to provide high-value services or supply which can lead to liability claims and/or operate in the public domain then limited liability is important. In such situations, your personal finances and assets are protected. Operating as a sole trader does not have this benefit.
- Tax efficiency: More opportunity and great flexibility are offered by limited companies in the case of taxation on profits and on personal income. The profits of companies have a rate of 20% Corporation Tax. Before 1st April 2015, Corporation tax had two rates; if profits were £300,000 or above then the corporation tax was 20% and if the profits were £1,500,000 then the corporation tax was 21%. But not the rate is 20% regardless of the size of the profit. On the other hand, sole traders pay 20% income tax on their profits of £31,865 or above; 40% income tax if their profits are between £31,868 and £150,000; and the rate is 45% for profits above £150,000.
The directors can keep their income level below the higher bands by taking remuneration in a combination of dividends and salary. This results in more money being available for reinvestment or distribution among the shareholders and directors. Sole traders don’t have any such strategy to save tax.
- Professional Status: A professional and corporate image is created by a limited company, thus boosting the value of the business. More corporations and industries like to do business with companies, instead of sole traders. This is because limited companies are considered to be more established, credible and committed. Sense of security is also provided by limited liability to certain industry professions while choosing to use the services of a new business or while investing.
Although operating as a limited company has greater administration costs and accounting requirements, requiring more attention and time, the professional and financial gains cover these drawbacks.
Disadvantages of operating as a limited company
- Must incorporate the company with Companies House.
- Generally, there are more costs to set up.
- One cannot be a director of a company if he is disqualified director or un-discharged bankrupt.
- There are certain restrictions with regard to the company name.
- The information relating to the owner of the company and the company are displayed on the public record.
- There are more complex, time-consuming accounting and administration requirements.
- The accountancy costs are more expensive. A professional accountant might be required.
- Withdrawal of money form companies can be difficult.
Starting a sole trader business is quite easy. The administration and registration requirements are very simple and one can begin trading any time he likes. Operating as a sole trader does not require working alone and one can employ people to work for them. Ultimately the owner is personally and wholly liable for the business and the debts.
On the other hand, as there is no legal distinction between the personal finance and the business finance of a sole trader, one does not have to go through a complex procedure in order to make money for personal use.
Responsibilities and Rights of sole traders
- Maintaining accurate accounting and business records – like that of costs, sales and expenses.
- Unlimited liability – all the business claims and debts are the liability of the sole trader alone.
- Completing Self-Assessment tax return annually for HMRC
- Payment of Class 2 National Insurance every week or twice every year
- Payment of income tax and Class 4 National Insurance on all profits of the business.
- Registering for VAT (value-added tax), if it is expected that the earning will exceed the threshold of £82,000 a year (2015-16)
- Responsibility to register as an employer (in case applicable).
- Payment to employees through the PAYE.
- Responsibility to adhere to requirements of health and safety-related top the workplace for employees.
- In case one is planning to provide a contract or a subcontract service to the construction industry, He must register with CIS (Construction Industry Scheme)
Advantages of operating as a sole trader
- There is no requirement to register with the Companies House and there are no registration costs.
- It is easy and quick to set up online via HMRC.
- Usually, a small amount of capital is required to start the business.
- The accounting requirements and paperwork are minimal in comparison to a limited company.
- Either there are no accountancy costs or are very small.
- The owner has full control over the business.
- The owner enjoys ownership of all the assets of the business.
- Tax relief is available on all business expenses and purchases.
- The owner can retain all profit after tax.
- The details about the owner and his business are private.
Disadvantages of operating as a sole trader
- Unlimited liability – debts and liabilities of the business are the owner’s debts and liabilities.
- It can prove difficult to raise capital and to set up and grow a business.
- Only one person has to take all the responsibilities and decisions.
- The owner has to pay income tax on all profit and it can be as high as 45%
- The owner is responsible for paying tax and National Insurance contributions.
- Status – Generally sole traders seem to be smaller and less established compared to limited companies.
- Certain companies may not deal with sole traders – Because it is considered risky.
- It can prove to be difficult to manage work, take holidays or sick leaves.
- Sole traders are not eligible for Statutory Maternity Pay.
- One cannot leave the money in the business as a strategy to save tax – All money is subject to tax, in the same financial year it is earned.