Setting up on your own? Deciding whether to become a Sole
Trader or Limited Company? Read Nasa's short guide...
Introduction
If you are new to contracting, the decision to work as a Sole
Trader or via your own Limited Company can be a tough one. It is a
daunting time as you have to digest a lot of information quickly
whilst at the same time, weighing up the pros and cons of each
option available to you. Making the decision about how you
are going to trade is very important and needs careful
consideration. This is why we have produced this short but
informative guide, providing useful information regarding both Sole
Traders and Limited Companies that should offer you some assistance
in making your final decision.
So, what are the negative issues with each option? What
are the positives? What are you going to get out of each
option? Which one is ultimately going to give you more of
your money? I'm sure there are many questions running around
your head and the aim of this document, is to answer them in
simple, basic terms without adding more doubt and confusion at an
already complex time for you.
So, let's start with the basics…
What exactly is a Sole Trader?
A Sole Trader is basically a business that is owned and run by
one individual. It's as simple as that. You receive all
profits, obviously subject to the necessary taxes, but you also
have unlimited responsibility for all losses and debts. Every
asset of the business is owned by you but unfortunately all the
debts of the business are also your responsibility. As a Sole
Trader, you can use a trading name rather than simply using your
personal name if you prefer.
What exactly is a Limited Company?
A Limited Company is a company in which the liability of the
members or subscribers of the company is limited to what they have
invested or guaranteed to the company. (If a Limited Company
has large debts, unlike Sole Traders, the members of the company
would not be personally liable for them.) Limited Companies
are usually limited by shares which means that they can be further
divided into public companies and private companies.
Down to the nitty gritty…
Let's start with the positives!
What are the main advantages of a Sole
Trader business?
- Sole Trader businesses are very easy to set up - you just need
to notify HMRC within 3 months of starting the business
- Start-up costs are usually low
- As the owner you have sole and full control over the
business
- Sole Traders do not have a huge amount of administration,
accounts or form filling to do, especially compared with that of a
Limited Company. You simply need to complete an annual
self-assessment tax return.
- All profits are the owners and your financial information is
not available publicly whereas Limited Companies have to file their
annual accounts with Companies House which can be accessed by
anyone.
- Sole Traders don't need to register a company as they can
simply use a trading name i.e. David Smith trading as DS IT
Systems.
- If you decide to get some accountancy assistance (which is
always wise) for Sole Traders, fees tend to be less as there is
less work to do with a Sole Trader than with a Limited
Company.
- Sole Traders tend to have a more personal relationship with
local people as you will know about the local market you are
working in.
What are the main advantages of a
Limited Company?
- A Limited Company is a completely separate entity from its
members. With Sole Traders the individual and his/her
business is treated as one entity which carries a big risk.
With Limited Companies, everything relating to the business is
separated from you personally so you are protected if anything goes
wrong and the business fails.
- With a Limited Company, you will most probably pay less tax
than you would if working as a Sole Trader. As a Sole Trader,
your income will be subject to PAYE and NI contributions. As
a Limited Company you have the benefit of choosing to pay yourself
a lower salary and then a dividend payment.
- In certain situations, you may find that being a Limited
Company opens more doors for you. Many businesses prefer to
deal with Limited Companies and simply won't use Sole Traders.
- A Limited Company can issue shares of various classes which
means that you can easily sell stakes in the company or transfer
the ownership of shares.
- With a Limited Company, you can fund your pension (and any
other employees of the company) as a legitimate business
expense.
Time for the negatives…
What are the main disadvantages of being a
Sole Trader?
- As mentioned previously, one of the main disadvantages of being
a Sole Trader business is that you are ultimately responsible for
your business and that includes its debts. Your personal
possessions could be at risk if your business fails.
- It can prove difficult if you are trying to get work with large
companies as they seem to only like dealing with Limited Companies
due to the fact that one individual available for providing the
services is not appealing.
- As a Sole Trader, you have no one to share the responsibility
of running your business. This can add a lot of pressure at
times particularly if there are areas of your business that you're
not so good at and could use some support.
- Sole Traders tend to work longer hours and it can often be hard
to take time off for holidays or illness etc…
- Development of your business is going to be limited by the
amount of capital you have personally available so if you are
thinking about long terms plans to really expand and grow your
business, becoming a Sole Trader probably isn't the option for
you.
What are the main disadvantages of running a
Limited Company?
- Running a Limited Company for many is considered a headache due
the administration, accounting and form filling that comes with it.
Some contractors consider it to be a laborious and time consuming
process.
- Accountancy costs are more expensive when running a Limited
Company although more and more companies are competing for your
business nowadays so fees are coming down.
- Finding an accountant is, in itself, a difficult and daunting
task. There are many accountancy practices out there offering
very competitive rates so how do you choose an accountant that's
right for you? You have to put a lot of trust in an
accountancy practice so it's imperative that you choose the right
one.
- Limited Companies are apparently more strictly regulated than
Sole Trader business and information about the company is held
publicly as mentioned previously, and it is freely available to
all.
- IR35 - the government's status tests can cause terrible
problems to small limited (service) companies and can be extremely
expensive should you be subject to an IR35 investigation. It
is important to review IR35 in detail as it is a tricky and complex
piece of legislation and many contractors don't understand it and
don't even know if it will apply to them or if it does, what the
consequences may be. It is important to learn about what
you're letting yourself into! (If you would like further
information about IR35, please click here.)
Now that we have covered the main pros and cons of both Sole
Traders and Limited Companies, you should hopefully have an idea as
to which option you feel most comfortable with. It's worth
pointing out that if you're keen on opening a Limited Company but
the scale of it frightens you at this point, you should consider
starting out as a Sole Trader and then incorporating later on down
the line.
Also, it really is worth discussing your personal circumstances
with a professional - many businesses offer free start-up advice
and you may find that following some advice based on your own
personal situation, helps you to focus on which option really fits
with in with what you want.
There is also an additional option that may change your mind
about Sole Traders and Limited Companies altogether…
Umbrella Companies
An umbrella company is basically a company (with the same legal
structure of a personal Limited Company) that acts as an employer
to self-employed contractors working under fixed term contracts and
usually via recruitment agencies. In essence, the umbrella
company will invoice the agency on your behalf for the work that
you have completed, the agency will then pay the umbrella company
who will in turn pay you a salary, obviously making the necessary
deductions for income tax, national insurance and associated taxes
plus their fee for the service. (Umbrella companies pay you
through PAYE and you should receive a payslip from them in exactly
the same way as you would if you were in permanent
employment.) You also have the added benefit of offsetting
some of your income through claiming expenses such as travel,
meals, accommodation etc…
Umbrella companies have become more and more popular over the
last decade and one of the main reasons for this is the nightmare
of IR35. IR35 is a piece of legislation put into place by the
government back in April 2000 which basically tests individuals
self-employed status to see if they are truly self-employed (and
eligible to make use of small company tax reliefs) or merely
disguised employees who should be paying PAYE.
As commented on previously, IR35 has made huge impacts to some
businesses and in extreme cases, forced businesses to close.
IR35 investigations are not only time consuming and laborious, but
they can also be terrifying and extremely stressful. Many
individuals choose the umbrella company route to purely remove the
headache of IR35.
Umbrella companies are perfect for those individuals who are new
to contracting and just want to get started quickly without any
hassle or fuss, and also for those who are perhaps unsure of their
future or how long they will be contracting for. They are
extremely easy to set up, there is no hassle or administration
involved - the umbrella company does everything for you.
Certainly an option worth considering!
At a Glance
We have produced a table of the main points of both the Sole
Trader and the Limited Company options so that you can see how the
two compare at a glance. We have also included the umbrella
company along the right hand side for those who are considering
this option too.
|
|
Sole Trader
|
Limited Company
|
Umbrella Company
|
Risk (personal loss)
|
HIGH
|
LOW
|
ZERO
|
Cost to set up
|
LOW
|
HIGH
|
ZERO
|
Work involved to set up (admin)
|
LOW
|
HIGH
|
LOW
|
Work involved to maintain (admin)
|
LOW
|
HIGH
|
LOW
|
Business information available publicly
|
NO
|
YES
|
N/A
|
Limited development of business
|
YES
|
NO
|
YES
|
Control over your own taxes and salary
|
LOW
|
HIGH
|
NONE
|
All profits of business your own
|
YES
|
NO
|
NO
|
IR35 Applicable
|
NO
|
YES
|
NO
|
Summary
Obviously, it totally depends on your individual circumstances
as to which route suits you best however we hope this short guide
provides the basic information to help you understand each option
better, assisting you in making your decision. If you feel
that you would benefit from discussing your particular situation in
more detail with an expert, please feel free to contact us here at
Nasa Consulting. We are experts in this area and our
consultants have a wealth of knowledge and experience in advising
individuals on the options available.
Please contact us today on 0117 904 7755 or at
info@nasaconsulting.com.