What’s the tax differences between a sole trader and a Limited company? Who owns my business? What happens in the event of a legal dispute? Can I be sued? What about my tax return? What is my employment status? What about tax on profits? Losses? Extracting profits? Making Tax Digital?
As a sole trader you are the business and also its owner.
Who owns a limited company?
If you have a limited company, your company is a separate legal entity to its owner.
If the company is limited by shares, and you hold those shares, you are a shareholder.
As a director you are an officer of the company: you have a fiduciary duty to act in its best interests.
As a sole trader you will be sued personally unless you have suitable insurance e.g. products and services liability, professional indemnity, employer's liability etc.
As a limited company, in the event of any legal dispute, the company will be sued unless it has suitable insurance cover. It is exceptionally difficult and rare under UK law for anyone to sue a director personally for a company's wrongdoing although there are exceptions where a director may be held personally accountable such as in tax cases of fraud by the directors.
For sole traders, annual accounts are simple to prepare. Generally Accepted Accounting Practice (GAAP) is followed unless cash accounting is used.
As a limited company your accounts are prepared in the format specified by the Companies Act, and Generally Accepted Accounting Practice (GAAP), generally under FRS 105 or FRS 102. Software makes this a pretty easy task for most small companies.
HMRC requires you to convert your accounts into a tagged iXBRL format.
As a sole trader you prepare one tax return under Self Assessment. If you are below the VAT threshold you may enter a three-line summary of your accounts in the self-employed section of the return. Otherwise, you enter the accounts details, line-by-line version.
As a limited company is a separate legal entity, it prepares its own tax return and tax computations. You as a director (and possibly shareholder) also prepare a separate return for yourself.
If you make errors or mistakes in your self assessment tax return as a sole trader, you are personally accountable for them.
If a limited company makes errors or mistakes in its tax returns, the directors are not personally accountable for them unless the directors have committed fraud on HMRC.
If you are a sole trader, you are self-employed; you cannot be your own employee.
If you are a director of a limited company, a director is an office holder, and this does not automatically make you an employee in terms of employment law, the National Minimum Wage or for Tax Credits.
For Income Tax and National Insurance purposes company officers are treated as employees.
What are the differences between a sole trader and a limited company when it comes to tax on profits?
As a sole trader, you pay Class 2 & 4 National Insurance and Income Tax on the taxable profits of your business, or your share of profits if you are in partnership.
A limited company pays corporation tax on its taxable profits. Company tax rates are lower than higher rates of Income Tax.
A sole trader can offset trading losses against other income.
A limited company can flexibly offset its trading losses against its other income, but not against your income as an individual shareholder.
What is “extended carry back” and how does it apply to me and my business?
Extended carry back as a sole trader are trading losses arising in the years to 5 April 2021 and 2022 and can be carried back three years against profits of the same trade.
Extended carry back as a limited company are losses arising in accounting periods ending between 1 April 2020 and 31 March 2022 and can be carried back three years.
A sole trader may withdraw cash from the business without tax effect.
As a company owner/director of a limited company, you are taxed on:
Any income withdrawn from the company. If it is a distribution, it is taxed as a dividend. If it is earnings it is under PAYE and subject to NICs.
Most employment benefits received are taxable too.
What are the differences between a sole trader and a limited company on Making Tax Digital (MTD)?
VAT registered sole trader businesses with turnover exceeding the VAT threshold of £85,000 had to join MTD for VAT from April 2019. All other VAT registered businesses will have to join from April 2022.
MTD for Income Tax applies from April 2024.
As a limited company, VAT registered businesses with turnover exceeding the VAT threshold of £85,000 had to join MTD for VAT from April 2019. All other VAT registered businesses will have to join from April 2022.
MTD for Corporation Tax to be introduced from April 2026 at the earliest.