Limited Company vs. Sole Trader for CIS Contractors: Which is Right for You in London?

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Limited Company Vs Sole Trader: Which one should I choose?

If you're starting a business in the UK, one of the first decisions you'll need to make is whether to set up as a limited company or a sole trader. Both options have their advantages and disadvantages, and the choice you make will depend on your individual circumstances and goals. In this article, we'll explore the key differences between the two and help you decide which one is right for you.

Limited Company

A limited company is a separate legal entity from its owners. This means that the company can enter into contracts, own assets, and incur liabilities in its own name. The company is run by directors, who have legal and financial responsibilities for the business. Shareholders own the company and can receive dividends and share in the profits.

Advantages of a Limited Company:

• Limited liability: Shareholders are only responsible for the amount they have invested in the company. This means that their personal assets are protected if the company runs into financial difficulties.
• Professional image: A limited company may be perceived as more professional and established than a sole trader.
• Tax benefits: Limited companies can be more tax-efficient than sole traders, as they can pay corporation tax on profits rather than income tax.
• Easier to raise finance: Banks and investors may be more willing to lend to a limited company than a sole trader.

Disadvantages of a Limited Company:

• More administrative work: A limited company has more legal and regulatory requirements than a sole trader. This includes registering with Companies House, filing annual accounts and tax returns, and holding annual meetings.
• Higher costs: Setting up and running a limited company can be more expensive than being a sole trader.
• Less privacy: A limited company’s financial information is publicly available, whereas a sole trader’s is not.

Sole Trader

A sole trader is a self-employed individual who is personally responsible for the business. They are not a separate legal entity and do not have shareholders or directors. A sole trader can employ staff (running a payroll), but they are personally responsible for any debts or liabilities incurred by the business.

Advantages of a Sole Trader:

• Simpler to set up: There are fewer legal and regulatory requirements for a sole trader than a limited company.
• More privacy: A sole trader’s financial information is not publicly available.
• More control: A sole trader has complete control over the business and its finances.

Disadvantages of a Sole Trader:

• Unlimited liability: A sole trader is personally liable for any debts or liabilities incurred by the business. This means that their personal assets are at risk if the business runs into financial difficulties.
• Less professional image: A sole trader may be perceived as less professional and established than a limited company.
• Tax inefficiencies: Sole traders may pay more tax than limited companies, as they pay income tax on profits rather than corporation tax.

Can contractors be sole traders?

Becoming a sole trader is usually the simplest route into contracting in terms of admin and tax. You don’t need to register with Companies House, so won’t have to file annual accounts with them, and there’s very little admin to get started.

As a sole trader, you and your business are, legally speaking, the same thing. There is no distinction between yourself and your business, so you get to keep all the profits after tax. On the flip side of this, any business debts or liabilities are also your responsibility. If your contracting business runs into trouble, all the financial and legal responsibility falls to you to sort out.

Paying tax as a sole trader contractor

Contractors who operate on a sole trader basis must register for Self Assessment so they can report their earnings.

It’s important to keep accurate records of your business income and expenditure because this will help make sure you enter the correct information on your Self Assessment tax return, pay the right amount of tax (and claim tax relief on any expenses!)

Keep in mind that you might also need to pay fixed-rate Class 2 National Insurance contributions (NICs), as well as Class 4 National Insurance contributions on any profit you do make.

What are the benefits of being a sole trader contractor?

Plenty of contractors prefer being a sole trader because it’s easy to start up, and offers more flexibility. You’ll need to record all of your transactions (a process known as bookkeeping), and submit your Self Assessment tax return on time (and pay the bill!).

Are there any disadvantages to contracting as a sole trader?

You are totally responsible for your business, so if there are any debts or other liabilities it’s you that pays them out of your own pocket. This could mean your home or other personal assets are at risk if you don’t have the cash available.

You might also find that some contracting agencies won’t work with sole traders, which can have a massive impact on your ability to find work.

Operating as a contractor with a limited company

Limited companies are completely separate legal entities from their owners and directors, so you won’t be liable for the company’s debts, but this also means any profits belong to the company.

You’ll need to register the business with Companies House so that you can begin trading.

The benefits of running your contracting business as a limited company

The beauty of setting up as a limited company is limited liability. The company is a separate legal entity to you as the owner, so although the process can be a little more time-consuming, your personal assets are safe if the company can’t pay its bills.

It can sometimes be more tax-efficient too. Many small companies are run by people who are both directors and shareholders, enabling them to pay themselves a combination of a director’s salary and dividends.

Another benefit for contractors, in particular, is that starting a limited company rather than operating as a sole trader can help your business appear more credible. Many contracting agencies won’t work with sole traders, so running your business as a company can help you source more work. It can also be much easier to raise finance or sell the business.

What should contractors know about running a company?

As a company director, it’s your responsibility to make sure that the company submits a Company Tax Return and accounts and pays its bills on time. Because the company is separate from you as an individual, you’ll also need to submit a Self Assessment tax return to report and pay tax on any money you take out of the business for yourself.

Another consideration for contractors running a limited company is IR35. The rules were introduced to minimize the risk of people avoiding tax by setting up a limited company and working for a client through that when they would otherwise be considered the client’s employee if the company didn’t exist. IR35 can be very complicated to get to grips with, so always ask for help if you’re not sure!

Setting up a partnership

Setting up a partnership allows contractors to share the responsibilities, costs, and risks of running a business with other people. It’s a simple and flexible way for two or more people to own and run a business together.

You don’t need to register with Companies House, reducing some of the administrative burden. Instead, each partner is self-employed in their own right and then registers the partnership as an entity for Self Assessment.

Partnerships have no legal status in the way that limited companies have, so they simply act as a way of linking two or more self-employed people together, though partners can also be a limited company or another partnership!

Are there any disadvantages to setting up as a partnership?

If you go into partnership with someone, you must be absolutely sure you can trust them. Even then – make sure you have an agreement in place before starting up! This is because all debts and liabilities are the responsibility of each partner personally. Creditors can seize personal assets if the partnership runs into difficulties – even if your partner ran up the debt and you didn’t. You’re still liable.

Partnerships don’t (usually) file public accounts with Companies House so, like sole traders, partnerships can represent a bit of an unknown quantity. Other firms may be wary of doing business with you.

You might also find winding up your partnership to be a drawn-out (and therefore expensive) process. It’s another reason why a comprehensive Partnership Agreement, covering all aspects of the partnership, is essential.

What about Limited Liability Partnerships?

In some respects, a Limited Liability Partnership (LLP) is sort of between a limited company and a general partnership. It offers partners the benefits of limited liability like a company does, whilst also allowing them the flexibility to organize their internal structure like a normal partnership.

LLPs are separate legal entities to the people who own and run them, so the business will be liable for its assets, debts, and liabilities should things go wrong. The liability to each partner is limited to the amount they invested in the business.

In principle, two or more partners in any business can set up a Limited Liability Partnership (LLP), though they’re most commonly used by professional services firms, like LOYALS Accountants & Business Consultants.

Choosing between a limited company and a sole trader depends on various factors such as your business goals, financial situation, and risk tolerance. Both options offer advantages and disadvantages, and it's essential to carefully consider your circumstances before making a decision. Whether you opt for the simplicity of a sole trader or the additional protections of a limited company, ensure that you comply with all legal and regulatory requirements to safeguard your business and maximise its success. - Kris Nick

KRIS NICK is the founder of LOYALS Accountants & Business Consultants, a multichannel brand that aims to help businesses streamline operations and enhance performance. This newsletter is supported by top experts who provide insights into topics aimed at assisting London businesses. Subscribe now and don't miss out on guides that will help you improve by learning from the experts.