Sole trader and limited company – what’s the difference?

Deciding whether to operate as a sole trader or limited company is one of the first things to consider when starting a business. In this blog, we aim to give you a better understanding of these two legal business structures and help you make a more informed decision.

There are so many benefits to running a business as a limited company, but it won’t appeal to everyone. Operating as a sole trader is much simpler because there are far fewer filing and accounting requirements.

However, if tax savings, financial protection, and corporate prestige are at the top of your list, company formation may be the better choice.

You should also think about your future business plans, the industry that you operate in, the types of clients you want to attract, and the level of record-keeping and accounting you are really prepared to do (or pay an accountant to do).

If you find yourself struggling to decide between a sole trader or limited company business structure, we recommend speaking to an accountant or professional adviser for expert, tailored guidance.

The differences between a sole trader and a limited company

The help you understand the key differences between the sole trader and limited company business structures, we outline the main characteristics, advantages, and disadvantages of each one below.

Sole trader

A sole trader is a self-employed person who registers a business with HMRC. As a sole trader, you can work on your own or employ other people to work for you, but you will be wholly and personally responsible for the business and its liabilities.

There is no legal distinction between you and your business. You will need to register for Self Assessment, report your earnings and expenses on a Self Assessment tax return each year, and pay Income Tax and National Insurance contributions (NIC) on all of your taxable income.

Sole trader advantages

• You can register online in just a few minutes
• No need to incorporate the business at Companies House
• Nothing to pay to register the business
• Usually inexpensive to get started
• Minimal bookkeeping, accounting, and filing requirements compared to limited companies
• Accounting costs are usually lower – you may even be able to do your own accounts and tax returns
• Full ownership and control of the business
• Decisions and changes are quick and easy to make
• All profit after tax belongs to the sole trader
• No personal or business details are disclosed on public record

Sole trader disadvantages

• Sole traders have unlimited liability for all business debts and claims because there is no legal distinction between the person and the business, thus no distinction between personal finances and business finances
• The individual is wholly responsible for making all decisions
• Can be more challenging to raise capital
• All taxable income of the sole trader is liable for Income Tax and NIC
• Larger companies and lenders prefer dealing with incorporated business structures rather than sole traders
• Often viewed as smaller and less established than incorporated structures – limited companies are viewed as more professional and credible
• Not as tax-efficient as a limited company
• Not always possible to meet the criteria for Statutory Sick Pay and Maternity Pay

Limited company

A limited company is a type of business structure that is incorporated (registered) at Companies House. It is a distinct legal entity that is completely separate from its owners (members), which means that it’s responsible for its own finances and debts.

Companies are managed by one or more directors. They are appointed by members to run the business on their behalf, but it is common for directors to also be members.

The owners of a limited company benefit from reduced financial responsibility for business debts. This is known as limited liability.

Most companies are limited by shares and owned by members known as ‘shareholders’. Some companies are limited by guarantee and controlled by members known as ‘guarantors’.

The limited by shares structure is used by profit-making firms, whereas limited by guarantee is the preferred choice of non-profit organisations whose members do not take a share of trading profits.

Companies must pay Corporation Tax on all taxable profits, submit tax returns each year, and comply with a number of statutory filing and reporting requirements under the Companies Act 2006.

Despite the additional administration in running a limited company, it is an incredibly beneficial and tax-efficient structure for many businesses.

Advantages of a limited company

• A distinct legal entity that is separate from its owners
• Provides limited liability – this means that the personal finances and assets of members are protected beyond what they agree to invest or guarantee to the business
• Enjoy professional credibility and improved status
• Often viewed as larger and established corporations, even if they are owned and managed by just one person
• Appeal to a broader range of potential clients
• Often easier to raise capital from lenders and investors
• Can be easier to grow a business when it’s set up as a company
• Enjoy perpetual existence, which means they remain in existence beyond the involvement of the original owners
• Pay Corporation Tax on all taxable income
• Often more tax efficient
• Directors can pay themselves a mixture of a salary and dividends, which is more tax efficient
• Limited by shares companies can sell shares in exchange for capital investment

Disadvantages of a limited company

• Must be incorporated at Companies House – however, it does not take long, nor does it cost very much
• Must register with HMRC for Corporation Tax
• Sometimes costs more to set up and operate
• There are certain restrictions when choosing a company name
• Not possible to register a limited company if you are an undischarged bankrupt or disqualified director
• Must maintain a registered office address in the same part of the UK where the company is incorporated
• Directors, subscribers, and people with significant control (PSCs) must maintain a service address
• Information about the company is placed on public record – this includes the registered office address, service addresses, directors’ details, shareholders’ details, PSC details, filing history, and financial activity
• Accounting and filing requirements are more complicated and time-consuming than sole trader administration
• May need to hire an accountant
• You cannot simply remove money from a company as and when you please – you must have enough profit left after the deduction of tax and other expenses before doing so, and you must follow strict procedures to remove money and pay yourself

Do I have to register with Companies House to set up as a sole trader?

Sole traders do not have to be registered at Companies House. You only need to do this if you are setting up a limited company or limited liability partnership (LLP). To operate as a sole trader, you just need to register with HMRC for Self Assessment.

Registering for Self Assessment is a really straightforward procedure that can be carried out online in a matter of minutes. To do so, you will need to provide the following details:

• National Insurance number
• Full name and home address
• Personal contact details
• Name and address of your business – you can use your own name and home address unless you’d prefer a unique business name and separate trading address
• The date you started in business
• Main activities of your business

HMRC will send you a letter within a few days of registering online. This will contain your personal Unique Taxpayer Reference (UTR) and details of your responsibilities and obligations as a sole trader.

Tax efficiency – Income Tax vs Corporation Tax

Sole traders pay Income Tax on all profits above the £12,570 Personal Allowance (2024/25 tax year). Limited companies pay Corporation Tax on all profits, with rates ranging from 19% to 25%.

Depending on the amount of profit you make, a company may be more tax-efficient because Corporation Tax rates are lower than the rates of Income Tax, which are:

• 20% (basic rate) on annual earnings from £12,571 up to £50,270
• 40% (higher rate) on annual earnings from £50,271 up to £125,140
• 45% (additional rate) on annual earnings in excess of £125,140

By running your business as a company, you can minimise your Income Tax and NIC by taking a director’s salary up to your tax-free Personal Allowance (£1,048 per month/£12,570 per year). The rest of your income can be taken as dividends.

• Sole trader – advantages and disadvantages
• How to change from sole trader to limited company
• What does it mean to be a limited company?

A salary is a tax-deductible expense, so you won’t have to pay Corporation Tax on it. Dividends are paid from company profits after Corporation Tax has been deducted, so no Income Tax or NIC will be deducted from any dividends you receive.

However, you will start paying dividend tax on dividend income above £500 per year. This is the tax-free dividend allowance for 2024/25.

If you keep your total annual income below £50,270 (£12,570 Personal Allowance + £37,700 basic rate threshold), you will pay less personal tax through a company than as a sole trader.

How to change your business from sole trader to limited company

You can convert from sole trader to limited company in under 24 hours by sending an online application to Companies House. Simply check the availability of your company name using a company name check tool, choose a company formation package, and enter the following information on the application form:

• Company name
• Registered office address
• Director’s details (minimum of 1 director required)
• Shareholders’ or guarantors’ details (minimum of 1 required)
• PSC information
• Service address for each director, company secretary, subscriber, and PSC
• SIC code(s)
• Details of issued shares (if applicable)

Applications are submitted electronically to Companies House. Once approved, your new company will be ready to trade on the very same day and you will receive digital copies of your incorporation documents via email.

Do I need business insurance as a sole trader or a limited company?

Whether you decide to run your business as a sole trader or limited company, you will be under no legal obligation to take out any kind of insurance, unless you employ other people or are a member of a professional body that requires you to be insured. Nevertheless, we strongly urge all businesses to protect themselves against unforeseen events by setting up appropriate business insurance policies.