Limited Company Advantages and Disadvantages

Sole traders vs limited company: what's the difference?

The biggest difference between a limited company and a sole trader is liability.

A sole trader will have full liability for the business, this includes debts, losses and legal claims.

Whereas the owner of a limited company doesn't face any of that, they have limited liability. The company formation is seen to be separate from the owner and this comes with many advantages and disadvantages.

These advantages can help to reduce some financial stress and strain, leaving with you a greater return when it comes to tax return time.

Limited company business advantages:

1. Reduced personal liability compared to a sole trader -

   What has to be the biggest upshot of forming your own company is the protection that it provides.

   If you end up in the unfortunate position that your company is in trouble, then your personal finances and assets are treated as a separate entity and are therefore safe.

   Why?

   In a separation known as the "corporate veil", a limited company is treated as a legal 'person' and is treated independently of the people who own it.

   This means that should the company have any debts, legal claims or losses, the company is responsible, not the owners.

   The owner of the company will be a shareholder and so if the company falls into difficulties then the owner would only need to pay the creditors the nominal value of unpaid shares. Any personal assets the owner has will be protected.

2. Professional status -

   While the process of setting up as a sole trader is easier as the business is not registered with Companies House officially, it does leave you with fewer rights.

   Unless you were to get your business' name trademarked, then anybody is free to use the name and you have no recourse.

   However, (and this is where a limited company has the edge) when your business is registered with Companies House, your business name is trademarked, meaning nobody can use it.

   If you think how increasingly important it is to have a unique name in business and to be able to be found easily online, you begin to realise why this is a key factor when deciding to create a limited company.

   Aside from that, Limited companies do come across as bigger than they actually are, this is usually good for the image of the business as they can appear to be more professional.

   It can even impact the likelihood of attracting clients and investors, sometimes it can go as far as making the difference between getting a bank loan or not - simply because they look more secure.

3. Tax and planning -

   We all know we have to pay tax and we all do so, reluctantly in some cases but creating a limited company means a tax return of maximum 25% Corporation Tax on profits.

   This may still seem like a lot but sole traders pay 20 - 45% income tax on their profits so there are potentially big savings to be had.

   It also means that rather than withdrawing all of the profits every year and paying more personal tax on top of the Corporation Tax liability, you are able to keep the surplus income in the business, allowing you to pay for any future costs and growth.

   This is a much better option than withdrawing all of the profits and paying greater rates of income tax to then put (already taxed and therefore less) money back into the business when needed.

4. Higher personal remuneration -

   Creating a limited company is a way to allow you to reduce your Income Tax and National Insurance Contributions (NIC) as you can take a combination of a salary and dividends.

   Having a business as a limited company means that if you keep your company director's salary below the NIC lower profits limit, there won't be any Income Tax or Class 1 National Insurance to pay with these earnings.

   Equally, Corporation Tax will need not be paid on the salary by the company where the wages are considered to be a business expense.

   The remainder of your income can come in the shape of dividends. The dividends come from post-Corporation Tax profits.

   A real highlight is the Dividend Allowance, what this gives you is an annual allowance of £1,000. This means that you will not have to pay any personal tax on your first £1,000 of dividend income. Once you go above that you will be liable to pay Dividend Tax rates, though they are a lot lower than Income Tax rates.

   These personal tax allowances can save you thousands of pounds worth of tax every year. This is one of the really big advantages of a limited company as opposed to sole traders.

5. Separate legal identity -

   As we have already discovered, limited companies are considered to be a legal 'person' in their own right, this is unlike sole traders. The identity of the directors and shareholders is a completely separate legal entity in itself.

   This means that a limited company is able to enter into a contract in their own name, taking on debts against the companies name, not the directors.

   Limited company = limited liability and this is true for owners also.

   The owner of a limited company will find that they aren't liable for everything relating to the company. They are only liable for their unpaid shares and personal guarantees.

   So if the unfortunate were to happen and the company ended up being insolvent then the directors and shareholders would not be declared bankrupt, even if the company was. Obviously given the personal repercussions of being declared bankrupt, this can literally make a huge difference to the future.

   Some people understandably want flexibility with business ownership, life can throw a lot of things at us so flexibility is always good to have. With a limited company, you can sell or transfer ownership with little disruption to employees or clients. So if you don't intend to hang onto your business forever, creating a limited company can be the perfect option for you!

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6. Credibility and trust -

   We have touched upon a limited company that can provide a status that a sole trader does not get. However, it can go further than that, certain businesses will only work with other incorporated businesses - this is very much the case in the IT field, finance, and construction. So if you see yourself working for or with these fields, you may want to seriously consider a limited company!

   The reason for this style of working is due to the degree of risk that goes with the contracts that they award. If the risk is high, for example dealing with highly sensitive information or high-scale contracts then it is likely that your clients will require limited liability protection.

   It is unlikely a sole trader will even be considered for these types of contracts.

7. Investment and lending opportunities -

   A limited company is not restricted to one owner like a sole trader is. This means that should there be a need to raise any capital, shares can be sold to investors to make this happen.

   As a general rule, companies do have greater opportunities when it comes to lending than sole traders.

   Risking your own property can seem risky and not a very attractive option, with a limited company, there is no need for directors or shareholders to secure their personal property against the loan. This will provide peace of mind to many, I'm sure!

8. Protecting a company name -

   Do you want your business to stand out? To have its own identity? Perhaps those are silly questions, who doesn't!

   A company name should really be unique.

   Registering your business with Companies House provides that security that nobody else can use your company name, or even one that is similar.

   A sole trader does not get this luxury.

9. Pensions -

   People need to think about pensions, increasingly so. Company directors of limited companies can invest a pre-tax sum into a company pension scheme.

   So if you're running a limited company, you don't need to remove money from the business to place into a personal pension - this will face business and personal tax. Set yourself up with a company pension scheme and reap the rewards!

10. Splitting income -

    Limited companies have shares, these can be issued to a family member, including your spouse.

    You might be wondering why you would do this, well...it will allow you to split the profits and your personal tax liabilities will be minimised.

    If you issue dividends to your children or spouse, you are able to take advantage of their tax-free Personal Allowance, basic tax rate and the Dividend Allowance of £1,000.

    If you are the sole provider and/or you often provide financial support to your children then this is ideal.