For those considering starting a new business, deciding on the best structure for the venture is one of the first major decisions. While many start as a sole trader due to the simplicity, setting up a limited company can offer multiple benefits.
Setting up a limited company may not be for everyone, so in this article we will explore the scenarios in which it may be appropriate and the key factors to consider when making your decision.
Understand the basics: Sole Traders vs Limited Company
Sole trader
Operating as a sole trader is relatively simple, and is often the first choice option for new business owners. Less administrative work is required than with a limited company. Sole traders report their income and expenses to HMRC through a Self Assessment tax return, with income tax and National Insurance paid on profits.
Limited Company
Setting up a limited company separates the business from its owners. This is because a limited company is considered a separate legal entity from its owner. Filing annual accounts and corporate tax returns are the statutory obligation of the business, and the business will pay Corporation Tax on any profits that have arisen in any given accounting period. Owners of the company will only pay personal tax once funds have been withdrawn from the company. Typically, this is done through a small salary at the National Insurance threshold, and additional salary is paid via dividends.
Key reasons to set up a limited company
There are several key reasons why business owners may select to set up a limited company rather than operating as a sole trader. These include:
Tax Efficiency
One of the greatest attractions of setting up a limited company is the potential for tax efficiency. Corporation tax rates tend to be lower than higher personal income rates, depending on the rates of taxable profits. Company directors can take their income via a combination of salary and dividends, which may result in significant tax savings.
For example, £50,000 drawn from a company via a notional salary of £9,100 and dividends of £40,900 gives rise to an income tax charge of just over £3,230. A sole trader with profits of £50,000 would have a combined income tax and National Insurance tax charge of just over £9,730.
Please note that the above example ignores the effects of Corporation Tax on company profits for indicative purposes.
If your profits exceed £50,000 per annum, it’s worth considering incorporation. Below this amount, the tax benefits are minimal and may not outweigh the additional administrative work involved.
However, with the rate of Corporation Tax increasing from 1st April 2025, individual circumstances would need to be considered.
Limited Liability Protection
Those operating as sole traders are personally liable for all business debts, meaning that their personal assets could be at risk should the business fall into arrears. Operating as a limited company negates this risk, as separation is created between the business and its owners. This limited liability protection means that the owners personal assets are generally protected if the business runs into financial difficulties.
This is especially appealing for those operating in high-risk industries or dealing with significant financial transactions. The limited liability provided can provide peace of mind for owners and protect personal wealth.
Access to funding and investment
Limited companies may find it easier to secure external funding through loans or equity investments. Investors are typically more likely to provide capital to companies in which their risk is confined to the amount invested.
Incorporation may be a crucial factor to consider if you foresee the need for substantial external investment to grow your business.
Pension contributions
Limited companies offer more flexibility for directors to make tax-efficient pension contributions. Employer contributions made by the company qualify as business expenses, which can reduce the company’s corporation tax liabilities.
If long-term financial planning is a priority, the ability to make significant pension contributions is a key factor to support incorporation.
Professional Image
The ability to add Ltd to the end of your business name may enhance your company’s credibility, making you more attractive to larger companies. Many larger companies opt to work exclusively with limited companies rather than sole traders.
If you are hoping to build a strong professional brand or work with large corporate clients, incorporation may be a smart tactical decision.
Property Investment Companies
For higher rate tax-payers, renting property owned personally may result in higher levels of tax paid due to the Section 24 interest relief restrictions meaning mortgage interest is not a deductible expense against rental income. Mortgage interest instead receives a finance relief credit against an individual’s overall tax liability. In some cases, this can lead to a rental property being run at a loss for an individual.
However, mortgage interest is considered a deductible expense within a corporate structure, and as a result many people purchase properties within a limited company SPV or transfer privately owned property into a company.
Factors to consider before setting up a limited company
While there are several benefits to setting up a limited company, there are some key considerations to make prior to making your decision.
Increased administrative responsibilities
Running a limited company involves additional responsibilities, including the need to file annual accounts with Companies House, submitting corporation tax returns to HMRC, and maintaining statutory records. To ensure the proper and compliant fulfilment of these obligations, it may be necessary to hire an accountant.
Costs
While forming a limited company is relatively inexpensive, the additional ongoing costs can add up to a considerable amount. These can include accountancy fees and statutory filing fees.
It is important to consider the potential costs and ensure that your cashflow is in order.
Withdrawal of profits
Unlike a sole trader, directors of limited companies need to follow formal processes when withdrawing funds. This is usually done via salaries and voting dividends, and requires careful tax planning and compliance. Dividends can only be distributed from specific reserves and so the profitability of the company at any given point in time should be investigated before distribution is made.
Loss of privacy
Limited companies are required to publish certain information on public registers, which can be accessed through Companies House. This information includes details of the company’s directors and financial accounts. This can be of concern to some business owners.
Making the right decision for you
There is no one-size-fits-all solution when it comes to selecting a business structure for your new company. Your decision depends on business goals, long-term plans and financial situations.
At Cooper Associates Accountants, we can help you to decide on the best structure for you. Our team of experienced professionals can take your business’s unique circumstances into consideration, providing bespoke advice to suit your personal goals and objectives.
Reach out today to find out how Cooper Associates Accountants can help you get your new business off the ground.
