Normally, small businesses in the UK are either operated as a sole trader (self-employment) or limited companies. Knowing key features of both the structures can help you decide which works better for you.

Sole trading

Sole trading is the easiest business structure- free registration, no hassle to set up, very less reporting and compliance requirements. You solely can decide where/how much to invest, what/where to sell etc. You enjoy all the profits (after tax) and bear all the risk of loss.

Company

A limited company is an entity considered separate from its owner. So, the debts companies bear do not transfer to the owner. If the company fails to settle the debt, the owner is not responsible to pay it personally.

The one who intends to form a company should contribute share capital. To operate as a limited company, you have a set of rules (company law) to comply with, some formalities to follow, and additional reporting requirements. You can still take out the money from the profit but may need to pay income tax on the distribution of profits.

Which structure is better in the UK, limited company or sole trading?

Answer to this question depends on individual circumstances. For some, sole trading benefits and for others, limited company is more suitable. An investor in the UK needs to see different factors while comparing limited company versus sole trading.

What are the reasons for choosing sole trading?

A sole trading might be a better option for a very small business because of:

Easy and quick set up

How a sole trader is set up is simple. You can register your sole trading business with HMRC quickly, without preparing any documents. No need to register with Companies House. A limited company setup follows a long process. You need to prepare several documents (memorandum of association, article of association etc) to register for company.

Confidentiality

Public can access some private information (address, date of birth etc) about the director via Companies House portal. Since sole trader does not need to report to the Companies House, his/her information is not available in the Companies House record for the public.

Independence

In a company, if it has more shareholders, one cannot choose to operate it by his/her will. It may be difficult to work independently. But a sole trader can handle the business in his/her own way.

Less compliance cost

The limited company, needing to prepare the accounts based on Financial Reporting Standards (FRS) and the company law, might need to hire accountants. Sole traders, not having such complex compliance requirements, can file the returns on their own.

Why to choose company?

In some cases, it might be worth setting up a limited company in the UK. What the UK company might offer you as benefit is:

Minimum liability:

A sole trader enjoys all the business profits by himself/herself. But if the business is unable to settle the liabilities, the owner himself/herself should pay the debts using personal money/assets.

In case of the company, the owner is not personally obliged to settle the company’s debts. The creditors or lenders cannot sue the owner for not paying the debts.

So, if you want to run a business but are afraid of the huge debt, the company is suitable structure.

Access to funding

If a company earns good profit, lenders feel safe to lend money. Also, the company can raise capital by issuing shares which is not possible for a sole trader.

Is the company more tax efficient or the sole trading?

Registering a company avails tax reliefs like Research and Development relief, group loss relief, incorporation relief etc. Such relief is not available for sole traders. Companies do not need to pay Class 2 and Class 4 National Insurance contributions like sole traders.

On the other hand, only the sole trader/self-employed gets advantages of annual exemption on capital gains tax, business asset disposal relief etc. Sole trader who receives property as a gift from a family member does not need to pay stamp duty land tax but the companies need to pay it.

FAQs

How to register as a sole trader/proprietorship in the UK?

Sole trader registration is done through HMRC gateway. You’ll get your Unique Taxpayer Reference (UTR) by post in 10 working days (21 days if you’re abroad). Once you register as a sole trader with HMRC, you can file your income in your self-assessment.

How can I change/transfer from sole trader to limited company?

A sole trader can transfer to the company by notifying HMRC that you stopped being a sole trader, then forming a company and transferring the assets and liabilities to the company. There might be certain tax implications on such transition, so expert advice is useful.

How do I pay myself from a limited company in the UK?

You can pay dividend from the company to yourself. Make sure your company is earning profit to cover the dividend. Note that dividend above £1,000 is taxable in the UK.

How is a sole proprietorship taxed in the UK?

A sole trader pays tax ranging from 20% to 45% based on the amount of total income (including salary, interest and all income).

How much does it cost to register a sole proprietorship in the UK?

You can register as a sole proprietor for free.

How do I declare myself as a sole proprietor?

You can declare yourself as a sole proprietor in the self-assessment form.

How can I take money out of my business without paying tax in the UK?

A sole trader gets a trading allowance (not available for property investors) of £1,000 tax free. Similarly, if your total income is less than £12,570, no tax is payable. And a company director can withdraw £1,000 of dividends as tax free. But amount above these thresholds are taxable in the UK.

How much tax does a limited company pay in the UK?

The rate depends on the amount of profit the company earns-

• 19% up to £50,000
• 19% to 25% between £50,001 to £250,000
• 25% above £250,000

How much does it cost to set up a limited company in the UK?

Fees for registering a company in the Companies House is just £10 but you might need to consult an accountant who might charge some more for preparing documents.

Conclusion

Choice between a limited company and a sole proprietorship can sometimes be tricky (as it involves tax implication). Reach your experts who can guide you the most efficient structure for you.