One of the most important decisions you make when you set up a new business is to decide what type of trading structure to use.
There are several less widely used legal structures – such as limited liability partnerships which are often used by accountancy and other professional firms.
However, the vast majority of small business owners work as self-employed (i.e. as ‘sole traders’ or ‘partnerships’), or via their own limited companies.
Please take some time to read the following points to help evaluate which trading structure is best for you.
Tax Issues
Limited companies, their directors, and the self employed are each taxed in different ways.
Limited company taxes
A limited company has a separate legal entity from its shareholders and directors, whereas the business and personal affairs of self employed people are treated ‘as one’ for tax purposes.
- Limited companies pay Corporation Tax on their annual profits.
- Directors and employees pay personal tax on any income they receive from the company.
- Shareholders pay dividend tax on dividends received from the company.
- Employees (including directors) pay income tax and NICs if they receive a salary.
- The company itself pays Class 1 Employers’ NICs on salaries it pays to employees.
Self employed taxes
If you are a sole trader, you pay income tax and Class 4 national insurance on your annual profits if they are above £12,570.
Your total tax bill is calculated when you file your annual tax return. The self-assessment deadline for submitting your return and paying any tax due is 31 January each year.
For the current tax and NI rates and thresholds, read our in-depth guide to how sole traders are taxed.
Value Added Tax (VAT) – companies and the self employed
Both companies and sole traders must register for Value Added Tax (VAT) if turnover reaches £90,000 or more per year (2024/25).
You can register for VAT voluntarily before your turnover reaches the VAT registration threshold if you wish to.
There are many benefits to doing so. For example, you can reclaim the VAT on purchases too.
You can find out more about VAT here.
Administration and Costs
Generally speaking, running a limited company is more onerous than being self employed.
As a company director, you also have a number of statutory and financial duties to keep on top of.
Limited company administration
All limited companies are registered with Companies House.
Companies file a Confirmation Statement and PSC each year and file a company of their annual accounts.
You can form a limited company for under £100, so the costs of setting up the business structure itself are minimal.
You can set up a company right away via our partner, 1st Formations – one of the UK’s leading company formations services.
The ‘hassle’ involved in being a company director is not significant.
Most companies use an accountant to take care of their tax affairs and deal with Companies House and HMRC.
Self employed administration
If you’re self-employed, you have less paperwork to worry about, although you must still keep accurate records.
When you first start up your new business, you need to inform HMRC when you become self employed.
You must also comply with any industry regulations (such as employment laws, health and safety rules, and discrimination rules).
Sole traders typically hire a bookkeeper or accountant to complete or help with their annual tax returns.
You can find details of how and when to do this in our popular guide – 10 Things You Must Do When You Go Self Employed.
For an insight into the key benefits of being self employed, read 7 Advantages a Sole Trader Has Over a Limited Company
Business structures and credibility
You may find it more advantageous to trade via a limited company in some industries or professions.
Some business owners find their customers more comfortable dealing with a limited company.
If you are providing professional services (as a consultant, or surveyor, for example), most clients expect you to trade via your own company – in fact, it may be a contractual requirement.
Employment Status
Although most types of business can be run under either type of trading structure, each has a very different legal status.
Limited company
A limited company is a legal entity with a separate legal status from its directors and shareholders.
If you are a director, you are an officer of the company. In many cases, directors are also employees of their companies.
Even though you are working for yourself, you are not considered ‘self employed’ for tax purposes.
Self employed
As the name suggests, as a self employed person, you cannot also be an ’employee’ of your new business. You are the business.
This means that both you (the individual) and your business share the same legal and tax status.
Business structures and liability
Following on from employment status, your liability also differs between structures if things go wrong.
Limited company liability
A limited company is a separate legal entity. So, if something goes wrong, the company, not its directors, is held liable.
If your company fails and owes money to creditors, you will not have to pay the creditors out of your own personal assets.
This is unless fraud or other offences have taken place.
The liability of company directors is therefore limited, hence the term ‘limited liability company’.
This is a key advantage that running a business as a limited company has over being a sole trader
Sole trader liability
As a sole trader, you are personally liable if things go wrong. This might happen if your business gets into debt, or faces a legal claim from a client or employee.
If your business goes under, creditors can pursue you for your personal assets if you are self employed.
For these reasons, we always recommend that you discuss your business with an accountant before deciding upon the right legal structure. You should not rely solely on the information provided in this article.
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