Nic Redfern
Duncan Ferris
When you set up as a freelancer, you need to decide the structure of your business. What works for one company might not work for another, so it’s important that you consider the pros and cons of each option and practice due diligence to make an informed decision.
Read on to find out if you should register as a sole trader or limited company.
Sole trader vs. limited company: what’s the difference?
When you’re starting out as a small business owner, it’s important to understand the implications of your company’s legal status.
In the following sections, we’ll cover the options available to UK businesses, as well as what each entails.
What is a sole trader?
As a freelancer, you may feel that you are your business. Registering as a sole trader would turn this feeling into a legal standpoint.
A sole trader is a self-employed individual with full ownership of their business. The business does not have a separate legal identity from that of the owner, so a sole trader accepts full liability for their business.
As a sole trader, you keep all your profits after tax. You do not pay corporation tax or take a salary because your profits are your salary, and you are taxed on them accordingly through self-assessment. Because there is no legal distinction between a sole trader business and the owner, you are responsible if you run into financial difficulties.
You may find it helpful to open a sole trader bank account if this description applies to you, to ensure you can keep track of your business finances separately from your personal accounts. For more information, read our guide to self-employed bank accounts.
What is a limited company?
A limited company is legally distinct from the identity of its owner, so it can have more than one owner (or director). Each owner has limited liability for the business, meaning their personal finances are not implicated if the company struggles financially.
If you register a limited company, you create an independent entity that you work for – even if you founded it.
You do not take the profits as wages as those profits belong to the company. Instead, you may pay yourself a salary, or choose to be paid in dividends, which are paid only if the company makes a profit. Alternatively, you might choose to be paid a split of salary plus dividends.
Should I set up as a sole trader or a limited company?
Both business models involve pros and cons, so let’s examine these in depth with regard to different aspects of your business.
Tax
Limited companies are registered with Companies House, which means they are required to pay Corporation Tax. Sole traders do not have this obligation but must pay income tax at the standard rate as well as National Insurance on all profits.
If you’re a freelancer or contractor, you may be affected by off-payroll working rules, also called IR35. It is important to investigate how this may impact you from a tax perspective before setting up your freelancer business.
» MORE: What is IR35?
Earnings
Sole traders retain all their profits after tax, which is paid via your self-assessment tax return. Earnings are therefore entirely dependent on performance.
With a limited company, however, you have the option to take a salary or dividends, or split take-home income between the two. If you take a salary from your limited company, you will need to register the company as a PAYE employer and ensure that income tax and National Insurance contributions are correctly deducted from your salary.
The amount you pay in tax beyond your personal allowance and your tax-free dividend allowance will depend on your tax bracket.
You can find more information about tax on Gov.uk, or you may consider asking a tax adviser or accountant for more personalised advice.
Responsibility
Being a sole trader may entail less admin than setting up as a limited company, but it may also involve greater personal risk, as there is no legal distinction between your assets and those of your company.
If you run up debts as a sole trader, creditors may have the right to claim your personal assets to balance their books.
Because the owner of a limited company has limited liability, they may not be held accountable for the company’s debts. And, while a sole trader could become bankrupt should their enterprise fail, the owner of a limited company will usually not, as their assets may be protected if the company goes into liquidation.
However, limited liability does not protect you against acting irresponsibly and, as a director, you have specific legal obligations to your company. If you do not comply with these obligations and then your company goes into liquidation, you could still be held personally liable for its debts.
» MORE: Can my personal finances be affected by business insolvency?
Winding up
It is also worth considering how long you expect your business to continue. If you stop trading as a sole trader, then fewer actions are necessary. You must inform HM Revenue & Customs (HMRC) that you are stopping, and send a final tax return.
Winding up a limited company, however, has to be completed in a specific way depending on whether the company is solvent or insolvent at the time. Among other things, you will need to inform HMRC that you’ve stopped being an employer (if applicable), submit a final Company Tax Return and pay any corporation tax that is due. More information can be found on Gov.uk.
» MORE: How is being self-employed different to being a sole trader?
How to register your business
When it comes to declaring your small business’s legal status, you can take different routes, depending on whether you wish to classify as a sole trader or as a limited company.
Registering as a sole trader
Setting up a sole trader business is straightforward. You need to register for a self-assessment tax return with HMRC, after which you need to wait up to 10 days for your Unique Taxpayer Reference (UTR). You should therefore set up your business well in advance of when you are required to submit your tax return.
Registering as a limited company
To set up a limited company, you will need to register with Companies House.
You will be able to register for Corporation Tax when you register with Companies House. But if you have only registered your company, you must register for corporation tax within three months of when you started trading. Then you will need to begin filing your Company Tax Returns each year.
If you register as a limited company then you will be required to have a business name, and will need to register a company name with Companies House.
Setting up a business, whether as a sole trader or as a limited company can be tricky and time-consuming, so you may wish to seek advice from an accountant or financial adviser.
Do your research
The pros and cons can be difficult to weigh up, so consult friends and colleagues who have gone through the process and make sure that you conduct thorough research. Just remember, what was right for one business might not be right for you, so crunch the numbers – and do consider seeking professional advice.
» MORE: How to change a business account from sole trader to limited company
Dive even deeper
How to Set Up as a Sole Trader
If you have income from self-employment, you may have to set up as a sole trader. Sole traders have responsibilities including keeping accurate records and managing their accounts. You may also need to register for self-assessment. Find out more here.
Kristina Fox
Sole Trader vs. Self-Employed: What’s the Difference?
Day to day, there is little distinction between self-employment and being a sole trader. But what is the difference, and how does it impact on you? Let’s look at the meaning of self-employment versus sole trader.
How to Change a Business Account From Sole Trader to Limited Company
If you change from operating as a sole trader to a limited company, you’ll need to open a new account for the limited company. Here’s what to do, and how to make the switch as smooth as possible.
Jeff Salway
Suzanne Worthington