Here at Trafalgar, we‘re often asked about the benefits of incorporating a business into a limited company. So, we’ve put together a detailed guide to help you decide what’s right for you.
What is a Limited Company?
- A type of business which is registered at Companies House as a legal entity in its own right. It is completely separate from its owners.
- Legally, it can enter into contracts in its own name and is responsible for its own actions, finances and liabilities.
- It must appoint at least one director who will be responsible for managing the company.
- The owners of the company are known as ‘shareholders’, and own the shares which are issued by the company.
- The same person can be both the owner and director. So, you can set up a company by yourself, or with other people if you prefer.
To help you decide if going limited is the best option for you, we’ve examined the key differences between operating as a sole trader versus a limited company. We have highlighted the tax treatment and extra responsibilities you’ll need to consider before making your decision.
What are the differences between Sole Traders & Limited Companies?
As a sole trader you’re a one man band; you’re the business, the owner, the staff, and the manager. In comparison, if you decide to incorporate your business, it becomes a separate legal entity. You’ll become a shareholder, serving the company as a director.
In the unfortunate event that the business has a legal dispute, or worse still, if the business fails and owes money, as a sole trader you would be sued personally. As a limited company is a separate legal entity, the company finances are also separate to your personal finances, so your personal assets and credit rating are safe.
Tax on Business Profits
As a sole trader you’ll pay Income Tax and National Insurance on your business’ profits in the year that they’re earned. A limited company pays Corporation Tax on the business’ profits in the year earned. As it stands, company tax rates are lower than Income Tax rates.
As business profits for a sole trader have already been subjected to Income Tax, you’ll have no further tax to pay when you withdraw money from the business. However, any monies withdrawn from a limited company would be subject to Income Tax and National Insurance at the time a payment is made. It’s worth noting that, as a director of a limited company, you can decide when payments are made, which may allow you to gain certain tax advantages.
There’s no requirement to prepare formal business accounts as a sole trader, although we’d recommend some form of accounts are kept to help you successfully run your business, or to secure funding. As a limited company director, however, each year you are obliged to prepare and submit financial accounts which meet criteria set by the Companies Act, to Companies House. A company tax return, along with your financial accounts must also be filed online with HMRC.
There are no formal requirements to publish business information as a sole trader, whereas information about your limited company, including the financial accounts will be in the public domain. Each document filed at Companies House is readily available to be downloaded by third parties. However, you should be able to use your accountant as your registered office address if you’re concerned about making your home address public.
What benefits are there to incorporating a business?
As well as the differences already noted, here are some additional benefits to incorporating your business.
Being a director and shareholder of a company can provide you with a certain acclaim, portraying the success of your business. The reputation of your business will be enhanced, which will hopefully attract more customers.
Whilst obtaining funding is difficult for most businesses, having a company separate from yourself may make it a little easier.
As an employee, the company may provide you with a pension. This would be a tax-deductible expense, giving you a tax advantage over a sole trader.
As a shareholder, should you wish to retire, sell your business, or in the unfortunate event of you passing away, it’s much easier to transfer the business ownership than with a non-registered business.
There are many factors to consider before incorporating your business. That’s why we’d always advise you to speak to an accountant to find out what’s best for you. Get in touch with Trafalgar now or call 020 7940 3090 to speak to one of our dedicated advisors.