Sole Trader, Partnership or Limited Company?

3 min read

Factors to Consider When Choosing Between Self-Employment and Limited Company Operation

When starting a business, one crucial decision entrepreneurs face is whether to operate as a self-employed individual or establish a limited company. Several factors should be taken into consideration before making this choice. In this article, we will explore four key factors: limitation of liability, financial statements, administration and management, and taxation.

Factor 1: Limitation of Liability

One of the primary advantages of running a business through a limited company is the limited liability status it offers. This status protects the personal assets of the owner-managers from commercial risk, except when they knowingly continue trading and incur liabilities despite the insolvency of the company.

However, it’s important to note that the limited liability advantage can be undermined in certain situations. For instance, to obtain bank finance or credit, owner-managers of limited companies may be required to provide a personal guarantee, which nullifies the limited liability status. On the other hand, a sole trader can obtain sufficient public liability insurance to mitigate commercial risk. Despite this, many entrepreneurs still consider limited liability as a crucial factor when deciding on the business structure.

Factor 2: Financial Statements

The record-keeping requirements for a sole trader can be relatively basic, and a formal accounting system may not be necessary, although this may change with the implementation of the Making Tax Digital system. Typically, sole traders maintain records such as a simple list of sales and purchases supported by invoices. Their final accounts usually consist of a basic income and expenditure account without a balance sheet. Furthermore, the accounts of a sole trader are not made public.

In contrast, limited companies have more formalized record-keeping obligations. They must use a double-entry bookkeeping system and prepare final accounts, including a profit and loss account, a balance sheet, and statutory notes and statements. If the turnover of a limited company exceeds £10.20 million, it may also require an expensive audit. Additionally, the accounts of a limited company must be filed at Companies House and become public record. As a result, limited companies often face higher administrative burdens and increased professional fees.

Factor 3: Administration, Management, and Business Standing

A sole trader has more flexibility in terms of administration and management of the business. However, company directors have formal responsibilities to adhere to statutory regulations regarding company administration, accounts, and management functions outlined in the articles of association. This formalization indicates that a limited company is managed correctly, has long-term objectives, and is taken more seriously. Such perceptions can enhance the business standing of a company and increase the likelihood of meeting funding requirements. Lenders to sole traders must consider the absence of a balance sheet statement in the basic accounts and the personal financial influences affecting the sole trader. Private limited companies also offer advantages in terms of published financial statements, protection of the financial position from personal influences, and the option to increase security through directors providing additional personal guarantees. Limited companies tend to retain more funds within the business for future financial commitments, which supports year-on-year growth and sustainability.

Factor 4: Taxation

While the gap has narrowed in recent years, private limited companies still enjoy some tax advantages over self-employment. Corporation tax rates for limited companies are now 19% for all, while the basic rate tax for sole traders is 20%. Depending on the net profit before tax, incorporation can still offer tax-saving advantages. Moreover, limited companies provide flexibility for owner-managers to determine the proportion of dividends and salary they draw from the business, whereas sole traders are subject to fixed tax rates and thresholds. Limited companies also benefit from more favorable accounting treatment of deductible expenses, such as charitable donations, entertaining expenses, and the use of home as an office.

However, it’s important to consider various tax-related factors before making a decision. For instance,

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