Operating as a sole trader or incorporating as a limited company are both legitimate ways to run your business and each option offers different benefits.
As a sole trader, you run your business on your own, and you keep all your profits after paying income tax. You can even employ staff as a sole trader, as being a sole trader means that you are solely responsible for the business, but it does not prevent you from having employees. However, it does mean that you are personally responsible for any losses.
A limited company is simply an organisation set up by you as a means of running your business. You can set up the company alone, and work alone if you want, just like a sole trader. However, unlike a sole trader, a limited company is completely responsible for everything it does, and its finances are considered separate to your personal finances. This means that the company owns any profit it makes, after Corporation Tax.
Setting up as a limited company director may seem like the more attractive option, depending on your business needs and requirements.
How does a limited company work?
A limited company is owned by its members. If you are the only member, then you own the company. If you are the sole member of the company, then you are automatically the director.
There are a lot of legal responsibilities involved with being the director of a limited company, such as being responsible for the success of the company and ensuring the company is run fairly and without bias. The director is also responsible for keeping company records and for reporting changes to HMRC, as well as registering for self-assessment with HMRC and completing the company’s tax return every year.
As a limited company, you will be required to pay Corporation Tax (business tax). Your limited company must pay Corporation Tax on its taxable profits, which includes money made from trade, investments and selling assets. You must set your company up for Corporation Tax within three months of starting business, or you may face a penalty fine from HMRC.
Unlike self-assessment for sole traders, you don’t get a bill from HMRC telling you how much tax you owe. Instead, you must work out how much your company owes by filling in a Company Tax Return and working out your company’s taxable profits. Check with HMRC what these are, and what total reliefs you can claim in order to work out how much tax you will have to pay.
As director, you can hire others to help you with certain aspects of this role (such as an accountant) but you are still legally responsible for the company’s records and finances.
Different kinds of limited company
There are different types of limited companies. Most limited companies are ‘limited by shares’, which means that shareholders within the company are only responsible for the value of the shares that they own. This means that if the company gets into financial difficulty, the director is not personally responsible for these debts so long as the company has not broken any laws.
This type of limited company makes it an attractive option over operating up as a sole trader, as a sole trader is personally responsible for any financial losses and debts.
Another type of limited company is one that is ‘limited by guarantee’ which means that the director and the shareholders will financially back the company up to a certain previously specified amount should the company get into difficulty.
You could also opt to set up a public limited company, which means that shares in the company are traded publicly on the stock market.
Setting up a limited company
If you decide you would like to set up a limited company, you must register the company with Companies House before you can begin trading. Once you have registered your company with Companies House, you will receive a Certificate of Incorporation, which confirms the legal existence of the company and your right to begin trading.
You must also let HMRC know when you begin business. You need to register for self-assessment with HMRC and file a tax return each year. You will also need to send a company tax return to Companies House annually.