Sole Trader Vs Limited Company

INTRODUCTION:

Often, the term “self-employed” is used interchangeably with regard to these two structures, and while in some respects this is true, there are some fundamental differences between them and how they operate.

Strictly speaking, only a worker who operates as either a sole trader or a partnership is “self-employed”, and what this effectively means is that this worker is subject to tax him or herself via the self-assessment system on the profits of the business.

In contrast, while the limited company itself is “in business” (as a separate legal entity), the staff and directors of the company are actually all “employees and employed” by the limited company, although some of them can also be business owners by virtue of being shareholders.

But as the question: “Should I operate as a Sole Trader, or via a Limited Company?”, is very frequently asked by people starting off in business for the first time, let’s consider these two structures in a lot more detail!

If you need tailored advice, talk to us for Limited Company accounting or Sole Trader accounting support.

TAXATION DIFFERENCES

Considering each type of taxation in turn:

INCOME TAX

Sole traders are taxed on a self-employed basis on the full profits of the business earned within a particular tax year.

In contrast directors and shareholders are only assessable to Income tax in respect of either the salary or dividends that they withdraw from the business when these funds are withdrawn.

As such there are tax planning opportunities within limited companies to retain funds within the business and withdraw these in the future when it may be possible to utilise lower rate tax bands.

Likewise, where a director is also a shareholder it is sometimes possible for them to alter their salary / dividend split to withdraw funds tax efficiently.

For more information on this we have prepared a brief guide entitled: QA Salary and Dividends Strategy Guide, which you can download.

MAKING TAX DIGITAL (MTD) FOR INCOME TAX

From April 2026, Sole Traders will be phased into MTD for income tax based on the INCOME of their business in the previous tax year:

• From 6 April 2026: mandatory if qualifying income over £50,000 (based on the 2024/25 tax year).
• From 6 April 2027: mandatory if qualifying income over £30,000 (based on the 2025/26 tax year).
• From 6 April 2028: HMRC policy publication describes plans to bring in those with qualifying income over £20,000 (based on 2026/27).

MTD for Income Tax does not (currently) change the requirement to submit a self-assessment tax return each year, or the payment dates for income tax (and associated payments on account), which all remain the same.

It is fundamentally a change to how you keep records and how you report to HMRC during the year:

• Digital record keeping is required using HMRC approved software
• Similar to VAT:
  • You need to make summarised quarterly reporting to HMRC
  • Penalties will be applied for late submission on a points based system

MTD for Income Tax only impacts Sole Traders and “Private” Property Investors (those who own property privately instead of via a limited company) at the current time.

NATIONAL INSURANCE

As sole traders are self-employed they need to account for and pay Class 4 (formerly also Class 2) National Insurance Contributions.

Directors as employees of a limited company must pay Class 1 employee’s NICs, and the company itself must also pay Class 1 and Class1A employer’s NICs on director salaries and benefits respectively.

CORPORATION TAX

Only limited companies are required to pay Corporation Tax.

Given that Corporation Tax rates are now between 19 and 25%, and the rate is determined based on the profitability of the limited company, there is scope for an LLP to be more tax efficient than a limited company in those circumstances where directors do not have the flexibility of receiving dividends and therefore receive the majority (or all) of their income as a salary.

Nevertheless, salaries, benefits, and employers’ national insurance are all deductible for purposes of calculating Corporation Tax.

VAT

The treatment of VAT is largely consistent between both sole traders and limited companies.  But crucially businesses can take advantage of the Flat Rate VAT Scheme which can be more beneficial in those instances where a business incurs a limited expenditure which contributes to Input VAT deductions.

ADMINISTRATIVE DIFFERENCES

LIMITED LIABILITY

Probably the most significant difference between the two types of business structure!

Sole traders have unlimited personal liability for the debts and obligations of the business, if it is subject to legal challenge or business failure.

Whereas for a limited company the liability of directors is normally limited to the value they invest in the business.  Which is the value of their share capital, or the value they have committed to guarantee, depending on the type of company concerned.

SOLE TRADERS DO NOT HAVE SHARES

This is a fundamental difference which impacts a number of key areas:

• Raising Finance Capital – It is not possible to sell shares to raise equity finance for the business.  Nevertheless, sole traders can still raise finance in other ways such as loan finance.
• Transfer of Ownership – It is not possible to sell shares to transfer ownership.
• Separation of Ownership and Control – It is possible to structure a limited company to achieve the separation of ownership (by the shareholders) and control (by the directors).  This is not possible with a sole trader business.
• Extraction of Profits – All profits in a sole trader business are treated as earned by the owner.  Profits in a limited company are allocated to shareholders on the basis of their equity share ownership and may be withdrawn when they have been declared by the directors as “dividends”.

EMPLOYED VS SELF-EMPLOYED

As discussed in the introduction, a sole trader is self-employed for tax purposes, whereas in a limited company directors are directly employed by the business, and shareholders are only entitled to dividend investment income.

Where the director of a limited company is also a shareholder, then greater tax planning opportunities exists for extracting profits.

CONFIDENTIALITY

There is no requirement to have formalised legal agreements with partners or other directors when you are in business as a sole trader for yourself.

Whereas in a limited company the Articles of Association (AOAs) and Memorandum of Association (MOAs) are public documents which can be reviewed by anyone at Companies House.  Although companies can optionally also have Shareholder Agreements in place which can remain private.

OTHER DIFFERENCES

There are a number of other administration differences, but the main ones include the fact that sole traders are not required to hold board meetings (as there are no directors), or shareholder meetings (as there are no shareholders), and they are not required to make decisions by resolution.

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