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Setting up a limited company: the pros and cons

When you’re starting out in business, deciding whether to register as a sole trader or a limited company can be tricky. FreeAgent has taken a closer look at the advantages and disadvantages of registering your business as a limited company to help you with the decision.

Last updated: 29 Jun 2020 4 min read

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Before we dive into the details, it’s important to be aware of one big distinction between the two company structures. If you choose to register as a sole trader, you and your business will become legally one and the same. However, if you register your business as a limited company (which is also known as ‘incorporation’), your business will remain a separate legal entity from you. This legal separation can work both for and against you, as we’ll explain below.

Pros of trading through a limited company

1. You could end up paying less tax

Limited companies don’t have to make payments on account, whereas sole traders do. Limited companies pay corporation yax on their profits at a lower rate than the income tax that sole traders pay. In addition, limited companies don’t need to pay national insurance.

Despite these advantages, bear in mind that limited companies are not entitled to a personal allowance and the difference in tax savings is not always substantial.

2. You could claim more tax relief on expenses

When you register as a limited company, you’re entitled to more tax relief on some costs. For example, a limited company can claim relevant food and drink expenses as a business cost. Sole traders, on the other hand, can only claim this kind of tax relief in a handful of very specific situations.

3. It might be easier to attract investment

If you’re looking to secure some investment in your business, incorporation could be the path for you. As a limited company, you’ll be able to sell shares in your business. Sole traders, on the other hand, can only get investment if they go through the complex process of becoming a partnership.

4. You’ll have limited liability protection

As a limited company would be a separate legal entity from you, the company could own assets, incur debts and pay bills in its own right. This means that if the company was sued, your personal possessions couldn’t be seized to pay the debt (unless you’d given a personal guarantee to a company creditor). A sole trader, on the other hand, could have their personal assets seized to pay a company debt.

Cons of a limited company

1. You’ll encounter more financial admin

Whereas sole traders only need to file their Self Assessment tax return once a year, limited companies have to file:

  • a set of accounts
  • a confirmation statement
  • a corporation tax return

On top of this, each director usually ends up having to file their own self-assessment tax return, too. If you are set up as an employee of your company and take a salary, you’ll also need to register the company as an employer, and then set up and run payroll. 

2. You’ll face more rigid taxation rules

Unlike sole traders, directors of limited companies cannot draw money freely out of the business bank account. When a limited company makes a loss, it can only use that loss against its own profits. Sole traders, however, may be able to use a loss to decrease their Income Tax.

3. Directors of limited companies have certain legal obligations

As well as safeguarding the company’s assets, it would fall on you to make the decision to cease trading if you knew the company couldn’t survive. If you failed to meet any of these responsibilities, you could be fined or even go to prison.

4. You’ll have less privacy than a sole trader

Some parts of a limited company’s accounts are published on Companies House and are available for anyone to view. This means your figures will be visible to the public, along with your company’s registered address.

Is a limited company right for you?

Deciding whether or not to incorporate your business is not always an easy decision! As well as the pros and cons we’ve outlined here, there are some other factors to take into consideration and it’s well worth talking to an accountant to get some expert advice

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