Sole Trader vs Limited Company as a Tradesperson

When starting your business as a tradesperson, one of the first major decisions you'll face is whether to operate as a sole trader or as a limited company.

In this guide, we'll look at the key differences between these two business structures and outline the pros and cons of each for tradespeople.

Let's get started!

Sole Trader vs Limited Company: What's the Difference?

In essence, a sole trader is personally responsible for their business and its finances, while a limited company is legally recognised as a separate entity from the individual and any personal assets are protected.

What is a Sole Trader?

If you register as a sole trader, you run your business as an individual, and are recognised as self-employed. You are personally responsible for any profits and losses that incur in the business, along with paying your taxes.

When Do You Need To Register as a Sole Trader?

You will need to set up as a sole trader if any of the following apply:

• You are not setting up a limited company
• You earned over £1,000 from self-employment in the last tax year
• You need to prove that you're self-employed
• You want to make voluntary Class 2 National Insurance payments in order to qualify for benefits

How to Setup as a Sole Trader

If you believe becoming a sole trader is right for you, you will need to tell HMRC and action the following:

• Keep records of the sales and expenses of your business
• Send a self-assessment tax return every year
• Pay Class 2 and Class 4 National Insurance and pay Income Tax on your profits

VAT Rules for Sole Traders

This is something that applies to self-employed tradespeople, as well as those operating through a limited company.

If you have a turnover of over £90,000 (1 April 2024), then you will need to register for VAT. You can register for VAT voluntarily if it suits the needs of your business. An example would be if you sell to other VAT-registered businesses and you want to reclaim the VAT.

Note: This limit applies to your last 12 months of taxable revenue. If revenue declines below £88,000 over the previous 12 month period then you can apply to deregister.

Naming Your Business

You can use your own name for your business if you are a sole trader or choose another name if you prefer. It's not essential that you register your name, however you must include your business name on all official paperwork, such as invoices and letters.

There are some rules when it comes to naming your business as a sole trader. Sole traders must not do the following when naming their businesses:

• Must not include 'limited', 'limited liability partnership', 'LLP', 'public limited company', or 'plc'
• Must not be offensive or contain sensitive words or expressions
• Must not be the same as any existing trademarks
• Must not suggest a connection with government or local authorities (unless you have permission)

Pros and Cons of Being a Sole Trader as a Tradesperson

There are several advantages and disadvantages of becoming a sole trader. Below is a list of the pros and cons of a sole trader:

Pros

• ✔ Have complete control over business decisions, without a need of approval from directors or shareholders
• ✔ Keep any profits for yourself (after tax and NIC), as there aren't any other parties that require payment
• ✔ Straightforward process with minimal paperwork, simply register your business online via HMRC
• ✔ Greater privacy, as unlike limited companies your business and personal details are not publicly available

Cons

• ✖ You're personally responsible for business debts, risking personal assets
• ✖ Limited financing options, meaning you may have to rely on bank loans or personal funds
• ✖ No annual leave as self-employed you don't usually get paid for holiday or time off sick
• ✖ Income tax and National Insurance is paid as an individual, with fewer planning options

What is a Limited Company?

In this section, we will go over what it means to be a limited company. If you're unsure of what a limited company is, read on to find out everything you need to know.

A limited company is a type of business that is legally separate from the owners. In the UK, a limited company must be incorporated at Companies House. This allows the business to be a separate entity in its own right with a unique company registration number.

As a limited company is separate from the owners by law, this means:

• The company is responsible for its own actions and can sue and be sued
• The limited company can enter into contracts in its own name, including the employment of staff
• The company is responsible for paying its own liabilities and debts
• The company has the legal right to the money it makes from sales and can keep its profits

The owners of a limited company are protected by limited liability. This means that, in most cases, the private owners of the business are protected as the business is a separate entity in its own right.

Below, we will take a look at the different types of limited companies, the initial set-up and any relevant taxes.

Private Company Limited by Shares

What is a private limited company? The majority of limited companies are private. This is where ownership of the company is divided into shares that are distributed between the shareholders.

Each shareholder can purchase one or more shares in the company. Their liability is limited to the amount they paid for these shares.

In many private companies, there is just one share that a single shareholder owns. This means that the shareholder owns 100% of the business and can control it. In other companies, there are more shareholders than just one.

Each shareholder will own a percentage of the business. They are entitled to voting rights and the rights to any profits paid out as dividends depending on how many shares they own.

There are no maximum limits on the number of shares that a company can have and therefore, there is no limit on the number of shareholders within a company.

Private limited companies legally cannot offer shares to the general public. The shareholders of a limited company appoint directors to manage the business, although many shareholders appoint themselves as directors.

This type of business is extremely popular amongst small and large commercial businesses as it combines the potential share in profits with a clear restriction on financial liability.

Shareholders are only responsible for what they've agreed to pay for the shares, so their personal assets will not be at risk if the business suffers.

Public Limited Company

This type of company is divided into shares like a private limited company. The liability of shareholders is usually applied to the amount they have paid for their shares.

Before a public limited company can trade, it must have issued shares with a combined total value of at least £50,000. It will also need to have at least two directors and a company secretary.

Public limited companies can offer shares to the general public, and some companies also list their shares on a stock exchange. This type of limited company is usually not suited to small or new businesses but, larger and more well-established businesses.

Private Company Limited by Guarantee

Private companies that are limited by guarantee do not have shareholders. These companies have guarantors instead who agree to pay a fixed amount towards the company's debts.

This guarantee must be settled if the company can't pay its bills. In most companies with a guarantee, this guarantee is usually a nominal sum, such as £1.

Typically, that is the limit of each of the member's liability. This means that their personal assets are protected like a company that is limited by shares.

Guarantors appoint directors to manage the company. However, guarantors can also appoint themselves as a director if they wish. This type of company is used in many non-profit organisations. Any surplus income that is generated is usually reinvested in the business rather than being withdrawn as income.

How To Setup a Limited Company

If you believe that a limited company may be the best option for you and your business, you will need to set up as a limited company. To do this, you must do the following:

• Choose a company name
• Gather all of the relevant information needed to set up your company
• Prepare the memorandum and articles of association for the company
• Submit the incorporation to Companies House
• Wait to be accepted on Companies House and receive your certificate of incorporation
• Hold the company's first board meeting and write up minutes
• Establish the statutory registers required for the company
• Issue share certificates to each of the shareholders

Taxes for Limited Companies

As a limited company is a separate legal entity in its own right, it is subject to its own taxes. Once the business is incorporated, you will need to register for corporation tax with HMRC. Corporation tax returns must be filed regularly, and corporation taxes must be paid to HMRC.

The company may also be subject to some other taxes, including the following:

• Pay as You Earn via the payroll scheme if the company employs staff
• VAT if the turnover exceeds the VAT registration threshold or if you opt to register voluntarily
• Corporation Tax on gains when a company disposes of assets for a profit.
• Other taxes depending on the nature of the business and its trade

If your tax returns are not submitted or paid on time, there may be penalties and sanctions for a company and its directors. Most limited companies will appoint an accountant to handle their finances and ensure that all payments and returns are made on time.

Pros and Cons of a Limited Company as a Tradesperson

There are several advantages and disadvantages of a limited company. Below is a list of the pros and cons of a limited company:

Pros

• ✔ Potential tax savings through paying lower corporation tax rates (19% where profits are less £50,000)
• ✔ Dividends are not subject to National Insurance Contributions.
• ✔ More flexibility in how some expenses are reimbursed (such as meals, accommodation, and travel)
• ✔ Easier to attract further investment, with the ability to sell shares in your company
• ✔ Limited liability protection, usually meaning any personal assets aren't at risk

Cons

• ✖ More admin and reporting is required (such as issuing accounts, tax returns, payroll, etc)
• ✖ Stricter legal responsibilities for management and company directors
• ✖ Not as much flexibility in regards to income withdrawal compared to sole traders.
• ✖ Less privacy due to company information being publicly available via Companies House.

Summary

As you can see, there are many differences between a sole trader and a limited company. Hopefully, this article has provided you with a better idea of which business style is best for you.