In the UK there are normally two options for setting up in business. You can either be a limited company or sole trader. OK, there’s a bit more to it than that… but we’ll talk about that later. So what’s the difference?

Whether you’re just starting up a new small business or growing and existing one, it’s important to understand the difference between being a limited company or sole trader. They’re fundamentally different ways of running a business and there’s pros and cons to both options.

Sole Trader vs Limited Company in the UK?
Watch this video on YouTube.
Concerned about privacy? Please read our Privacy Policy before watching videos on this site - link at the bottom of every page. Thank you!

Limited company or sole trader in a nutshell

In the world of working for yourself there are many different ways of structuring your business. The two most common are:

  • Being a self employed sole trader
  • Owning your own limited company

Most people start out as being self employed but this certainly isn’t mandatory. You can go straight in to having your own company and there are many advantages to this.

In a nutshell you can view a limited company as a separate person. A limited company is a legal entity in its own right and keeps your business affairs somewhat separate from your personal affairs. You generally work as an employee for your limited company and you pay yourself a wage. This contrasts with being a self employed sole trader where everything you make is regarded as your income. There’s a bit more to it than that but as I say, that’s it in a nutshell.

Setting up as self employed

Anyone can become self employed in the UK (within reason) and if there’s just you in the business you’re generally regarded as a Sole Trader. If there’s a few of you it may be regarded as a Partnership, but you’re still self employed. It’s simply a case of doing some work and charging your customer.

At some point you need to tell HMRC that you’re self employed and complete a yearly Self Assessment tax return to pay any tax due. Tax is based on your business profits. Generally speaking you pay tax at 20% plus national insurance at around 10%. Individuals in the UK get a tax-free personal allowance of (at the time of writing) £12,570. See this page for the latest and historic UK tax rates.

Setting up a limited company

If you want to trade as a limited company things become a bit more formal. You need to register with Companies House and have a unique business name. Most people use a company formation agent to do this for you and banks such as Tide will even set the company up for you as part of opening a new account.

The limited company is an entirely separate legal entity. You don’t ‘become’ a limited company as such. You set up a limited company and the company will employ you as a director. The company is owned by its shareholders. The important concept to grasp is:

  • A limited company is run by its directors
  • A limited company is owned by its shareholders

In reality you will probably be the only director and shareholder but theoretically he directors and shareholder could be anyone. The shareholders can even be another limited company.

Similar to being self employed, limited companies pay tax on their profits. However instead of paying Income Tax the company pays Corporation Tax. The big difference for smaller businesses is that there’s no personal allowance for corporation tax. You pay corporation tax on ANY profits and (at the time of writing) this is at a rate of 19%.

In other words as a self employed person you can make £12,570 profit and pay zero tax. However if a limited company makes £12,570 profit it would need to pay £2,388.30 corporation tax (at 19%). Don’t panic though! There’s ways and means of taking money from your company in various tax-efficient ways. It’s more complex than being self employed though and that’s why I always suggest you have a good accountant.

Can I just help myself to money from my limited company?

NO! Think of your company as a separate person. Could you just take money from that person without asking first? Probably not. It’s the same with a company – even if it’s technically your company!

REMEMBER: Money a company makes belongs to the company, not you!

So if you want to take money from your company you need to follow the correct process and generally that’s going to be:

  • Paying yourself a wage through PAYE
  • Paying yourself a dividend

When you pay yourself a wage it reduces the company’s profits. So using the example above, if your company made £12,570 but you paid yourself a wage of £12,570 you would still pay zero tax. That since you’ve reduced your company’s profits to zero and you’ve taken a personal wage equal to your personal tax-free allowance.

What is PAYE?

PAYE in the UK is Pay As You Earn and it’s how regular folk pay their taxes. Normally your employer’s accounts or HR department look after this for you but as a director of your own company this falls on your shoulders. Generally speaking that means running a payroll system. Ask your accountant to do this for you, the costs should be nominal. You get a regular monthly payslip with any tax already deducted. The company will pay your income tax directly to HMRC.

Obviously the reality here is that you’re doing all this work. You’re paying yourself from the company. You’re paying HMRC from your company. But the point is that there’s a process that needs to be followed. You can’t just help yourself to money out of the business’ bank account. That would be misappropriate of company funds, embezzlement or fraud.

Having said all that, you can pay yourself dividends whenever you like (within reason).

What are dividends?

Dividends are a share of your company’s profits. Unfortunately dividends don’t reduce how much corporation tax the company has to pay since they’re assessed after tax. But they can be a more tax efficient way of withdrawing money from the company.

When you take dividends from your company you need to report these on your personal Self Assessment tax return. At the moment these are taxed at 7.5% and you also get an annual tax-free dividend allowance of £2,000. In practice you can pay yourself dividends at any time but verify this with your accountant. Remember your dividends are based on your profits, so if you haven’t made any profit you can’t take any dividends.

What is a director of a limited company?

Directors are legally responsible for running a company. The directors run the company on behalf of the shareholders. Directors have a duty to make sure the company is run legally and in the best interests of the company. The rules of play are generally described in the ‘Memorandum and Articles of Association’ (see below).

What is a shareholder of a limited company?

Shareholders own the company. They don’t really have a say in how the company is run – that’s the directors’ job. But the shareholders can appoint new directors so watch out!

What are the Memorandum and Articles of Association?

All companies must have a Memorandum of Association and Articles of Association. Think of these as the rule book for your company. You generally use standard documents for these and they’re established at the point of company formation.

Limited company in a nutshell

  • A limited company is a separate legal entity
  • It’s registered with Companies House
  • It needs to have its own bank account
  • The company is run by its directors
  • The company is owned by its shareholders
  • It’s taxed through corporation tax
  • You can be an employee of your limited company
  • You can take dividends from your limited company

A few scenarios of company structure

So with all of this in mind there are lots of ways a limited company can be structured. Here are a few scenarios for you to consider:

  • Sole ownership: You’re the only director and you’re the only shareholder. You are responsible for the day-to-day running of the company and you own all of the shares. So the company belongs to you. This is the simplest option.
  • Husband & wife ownership: You’re both directors and both shareholders. You’re jointly responsible for running the company and you both own 1 share each, making you 50% / 50% share holders. So the company belongs to both of you.
  • Team ownership: There’s 5 of you. You’re all directors and all equal shareholders. Each person owns 20% of the company and you’re all jointly responsible for running things on a day-to-day basis.
  • Parental ownership: You are a director of the company but your parents are the shareholders. Technically your parents own the company. You could take a wage through PAYE but only your parents could take dividends.
  • Parental management: Your parents are the directors of the company but you own it. In this scenario you could still take a wage as an employee and you could take dividends. Your parents would be legally in charge of the day-to-day running of the company but as the sole shareholder you could appoint new directors whenever you like (within reason).
  • Hands-off: Still using your parents as an example, they could be directors AND shareholders. You could be an employee but technically your parents own and legally run the business. In other words they could fire you and there’s not a whole lot you could do about it!

In the public eye

One potential down-side of a limited company is that everything you do is in the public eye. Anyone can visit Companies House and download potentially sensitive information about a company. This could include anything from the director’s home address through to their date of birth and signature. There are ways and means of hiding some of this information (speak to your accountant!) but generally speaking if your want your details to remain private a limited company is probably a bad idea.

Other complications of a limited company

You can see from the above that a limited company offers flexibility way beyond what is possible as a self employed sole trader. It’s also significantly more complicated and as such something you should get professional help with. I’ve always used an accountant to look after my limited company accounts and I also involve him in key decisions.

A few things to ponder:

  • What happens if your business partner decides to sell their share in the company?
  • What happens if your business partner dies?
  • What happens if a shareholder doesn’t want you to be a director?
  • What happens if you want to shut the company down but your business partner doesn’t?
  • What if you reach stalemate on a key business decision?

Realistically a lot of the above could equally be an issue for a self employed partnership. However in the world of limited companies it’s very common (and highly advisable!) to pre-empt issues by having a Shareholders Agreement in place.

What is a shareholders agreement?

If you’re the only shareholder then you can probably brush over this bit. However this is particularly relevant if you have one or more business partners. A shareholders agreement is an additional set of rules to govern what happens under specific scenarios. For example, what happens if someone dies? What happens if shares are sold? What happens if there’s a stalemate? These are all real life complications that happen all the time.

I would suggest putting a shareholders agreement in place as soon as possible and this is something you’ll almost certainly need professional help with. Your accountant may have a template they use with all businesses but the best option is to employ the services of a commercial lawyer to draw up an agreement suited to your personal and business needs.

What’s the difference between the Articles of Association and a Shareholder Agreement?

In a nutshell the Articles of Association are public and Shareholder Agreement(s) are private. Remember a huge amount of information about your company is downloadable from Companies House. However you may not want everything to be in the public eye.

Limited company or sole trader – what’s next?

If you can’t wait to get started remember Tide can set up your limited company and bank account together. Have a read of my Tide review here for a bit more information. This should get you up and running pretty quickly. You can set up a limited company yourself but I’d strongly suggest getting your accountant involved as they’ll almost certainly be helping you later down the line.

If you spot any errors in this article please get in touch. Don’t forget to subscribe on YouTube and remember you can get access to extra useful content by becoming a site member. Please also join our mailing list so we can keep in touch with you outside the world of YouTube. We are 100% privacy focused and you can unsubscribe at any time.

Thank you for supporting this independent website and best of luck on your small business journey!

Andy Mac