Arguably, the most important question you’ll need to ask prior to your company formation is, “Should I register as a sole trader or a limited company?” Your preferred company registration should depend on your business needs in relation to the following:
- company income
- projected business plans
- tax implications
- your company industry/market
- independent accounting and bookkeeping needs
To help you decide whether your business will be better suited as a limited company or as a sole trader entity, we’ll outline both definitions, their respective advantages and disadvantages, and what the registration process entails.
What Is a Sole Trader?
If your company’s launch is still in its infancy, the premature question of how to register a company as a sole trader will be better understood once you know what exactly is a sole trader:
Essentially, a sole trader is a self-employed individual; and the simple answer to how to register a company as a sole trader is simple to a degree: a sole trader must register a company with HMRC — but more on that later!
Sole traders have full responsibility for the business and its liabilities, regardless of the number of employees the business has (a sole trader can work on his/her own or employ a number of people).
As a sole trader, there will be no legal distinction between you and your business. Notably, you have to register for Self Assessment and file the relevant annual Self Assessment tax return, and pay Income Tax and National Insurance Contributions on all taxable income.
What Are the Advantages of Being a Sole Trader?
Sole trader registration is one of the most popular choices of starting a new business in the UK and is particularly common amongst those individuals launching their maiden business. But what’s so appealing about being a sole trader?
- There’s no need to incorporate your company at Companies House.
- There’s no registration fee.
- Comparatively inexpensive to launch a company as a sole trader.
- There is minimal bookkeeping, accounting and filing requirements as sole-traders could complete their own accounts (therefore accounting costs will be lower).
- Sole traders have comprehensive ownership and control of their business.
- Decisions can be made efficiently without the need for prolonged, collaborative decisions.
- All net profit belongs to the sole trader.
- The public record will not display a sole trader’s personal or business details.
What Are the Disadvantages of Being a Sole Trader?
To help you make a more informed decision about company registration, take note of the following disadvantages associated with being a sole trader:
- Since there is no legal distinction between a sole trader’s personal and business finances, they’ll have unlimited liability for all business debts and claims.
- The sole trader is completely responsible and accountable for all business-related decisions.
- It can be comparatively more difficult to raise capital.
- A sole trader’s entire taxable income is liable for Income Tax and National Insurance.
- Sole traders’ credibility may not be as reassuring for larger companies and lenders compared with incorporated business structures.
- Sole traders may endure the perception of being smaller and less established compared with incorporated structures.
- Sole traders are not as tax-efficient as limited companies.
- May not be possible to meet the criteria for statutory sick pay and maternity pay in a sole trader enterprise.
What Is a Limited Company?
A limited company is a business structure that is registered at Companies House. Unlike a sole trader, a limited company is a distinct legal entity that is comprehensively separate from the company’s owners and the company itself holds responsibility for its finances and debts. In this respect, the owners benefit from lower financial responsibility for company debts — this is known as “limited liability”.
A lot of limited companies are limited by shares and owned by their shareholders, whereas some companies are limited by guarantee and are owned by guarantors. Non-profit organisations where trading profits are not distributed to owners prefer to be limited by guarantee.
Limited companies are managed by one or more directors. These directors do not necessarily have to be the owners. However, limited companies have to pay corporation tax on their taxable profits, submit tax returns on an annual basis and by adhering to the Companies Act 2006, they must be compliant to statutory filing and reporting requirements.
Although evidently there are additional administrative requirements with a limited company, many business owners prefer this company structure for its tax efficiency.
What Are the Advantages of Being a Limited Company?
The credibility of a limited company and a “proper” business organisation is highly appealing for many entrepreneurs. The following “advantages of a limited company” may convince you to choose this over a sole trader registration.
- Limited companies are distinct legal entities, separate from the owners.
- A limited company provides limited liability; this means the personal finances /assets of shareholders/guarantors are protected over and above their agreement of investment/guarantee to the company.
- Limited liabilities exude a professional and credible status.
- Although a limited company may be managed by one individual, it’s invariably perceived as a larger and more established corporation.
- Limited companies are comparatively more appealing to a wider range ofpotential clients.
- It’s often less challenging to raise capital from lenders/investors with a limited company.
- Scaling and growing a business is often easier when set up as a company.
- A limited company can remain in existence even if the original company owners are no longer involved.
- Corporation tax is payable on all taxable income.
- Limited companies are more tax-efficient.
- Directors can pay themselves a combination of salary and dividends, which has far better tax implications.
- Shares can be sold in in exchange for capital investment.
What Are the Disadvantages of Being a Limited Company?
As above, you need to make an informed decision when it comes to company registration, and here are some things that may dissuade you from forming a limited company.
- Although company registration is not particularly time-consuming, a limited company must be incorporated at Companies House.
- Registration with HMRC for corporation tax purposes is a must.
- Limited companies may be comparatively more expensive to set up.
- There are certain restrictions when selecting a company name.
- You cannot register a limited company if you’re an undischarged bankrupt or disqualified director.
- A registered office addressmust be in the same region of the UK where the company was incorporated.
- Directors, subscribers, secretaries and People with Significant Control (PSCs)have to provide a service address.
- Information such as details of the registered office address, service addresses, directors, shareholders, PSC details, filing history and financial activity are placed on the public record.
- Administrative tasks are far simpler in a sole trader business as accounting and filing tasks are time-consuming in a limited company. Hence an accountant may need to be hired.
- Money cannot be displaced from a limited company on a whim. Before doing so, the company must have enough net profit and certain procedures must be adhered to when paying yourself money.
How to Register a Company as a Sole Trader and Limited Company?
There’s a simple answer to the question of how to register a company as a sole trader. And simply put, sole traders needn’t be registered at Companies House. This is only required if you’re setting up a limited company or limited liability partnership(LLP).
However, in order to run as a sole trader business, you have to register with HMRC for Self Assessment — a rather simple and straightforward procedure that can be completed online swiftly. When it comes to the details of how to register a company as a sole trader, you must provide the following details:
- National Insurance number.
- Complete personal details: full name and home address.
- Complete business name and address. Unless your business has its own name and a distinct trading address, you’re allowed to use your own name and home address.
- Date you started in business.
- The main activities of your business.
Within a few days of registering your sole trader business, HMRC will send you a letter containing your personal Unique Taxpayer Reference (UTR) and details of your duties and obligations as a sole trader.
Tax Implications for Sole Traders and Limited Companies
For sole traders, income tax is payable on all profits above their £12,500 Personal Allowance. As for limited companies, corporation tax is payable on company profits.
A company may be more tax efficient (depending on the amount of profit generated) since corporation tax is set at 20% and Income Tax rates vary:
- 20% (annual income of £12,500 – £50,000)
- 40% (£50,001 – £150,000)
- 45% (income exceeding £150,000)
The rate of your income tax and NIC can be minimised by running your business as a limited company and taking a director’s salary up to your tax-free Personal Allowance (at £12,500) or the NIC threshold (at £8,632) — please note, this is for the 2019-20 tax year. Additionally, the rest of your income may be taken as dividends.
Since a salary is considered to be a tax-deductible expense, corporation tax is not needed to be paid for this. Company profits provide the dividends once corporation tax has been deducted. Therefore, this segment of your income shall not be at the mercy of Income Tax or NIC. However, you will have to start dividend tax payments on dividend income above £2,000 per year.
If your total annual income remains below £50,000 (£12,500 tax-free Personal Allowance + £37,500 basic rate threshold), significantly less personal tax will be payable through a company (compared to a sole trader where the figures will be much higher).
Insurance Implications for Sole Traders and Limited Companies
Unless you employ individuals, a lot of sole traders and limited companies do not legally have to take out any form of insurance. If individuals are employed, then it is compulsory to have Employers’ Liability Insurance.
However, public liability insurance is highly recommended for all businesses as it protects them from property damage and personal injury claims.
Still wondering how to register a company as a sole trader or a limited company? Hopefully you will have a clearer idea of what’s best for your business, but don’t forget you can transition from a sole trader to a limited company in just three working hours via an online application at Companies House!
If you want professional advice and guidance on both sole trader and limited company registrations, contact our extremely helpful and friendly company formations team today!