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A limited company is one of the most popular legal structures for all types and sizes of businesses in the UK. This is due to the many professional and financial benefits it offers, all of which far surpass those available to sole traders or contractors working through an umbrella company.
To enable you to make an informed decision, we will provide an overview of the limited company advantages on offer. We will also outline the potential downsides of company formation when compared to the sole trader structure.
Top 10 limited company advantages
The principal reasons for trading as a limited company are limited liability, tax efficiency, and professional status. However, there are a number of other limited company advantages available. Below, we discuss each one in turn.
1. Minimising personal liability
The biggest benefit of forming your own company is limited liability protection. Simply put, should your company run into trouble, your personal assets will be secure. This is because a limited company is treated as a separate legal entity; a legal ‘person’ in its own right. Therefore, the business is entirely separate from the people who own and manage it.
This separation is known as the ‘corporate veil’. Any debt, losses, or legal claims associated with the company are the responsibility of the company itself – not its owners (shareholders/guarantors) or directors.
As a shareholder, you will have no legal obligation to pay more than the nominal value of the shares you hold. If your company becomes insolvent and is unable to pay its creditors, you will only be required to contribute the nominal value of your unpaid shares. Beyond that, your personal assets will be protected.
It is common practice to set the nominal value of most shares at £1. This means that your liability could be as little as £1, depending on the number of shares you issue and purchase. However, there are rare instances (such as fraud or wrongful trading) whereby the corporate veil might be ‘lifted’ or ‘pierced’, which may result in shareholders (and directors) being personally liable for company debts.
Sole traders, on the other hand, run a much higher risk. They are personally liable for any and all business debts, losses, and liabilities. As a sole trader, there is no separation between you and your business. If the business owes money, you owe money. Therefore, your personal assets, including your home and savings, could be seized to pay your creditors.
Limited liability is crucial if you plan to provide high-value supplies or services that could lead to liability claims. If any such situation were to arise while running your business as a limited company, you would not be forced to use your own assets to cover these liabilities unless you gave a personal guarantee to the company or you were found guilty of wrongful trading or other criminal acts.
2. Professional status
Your professional status and image will improve considerably when you start trading as a limited company. Whilst the activities, ownership structure, and internal management of your business may be the same as when you were operating as a sole trader, companies are held in much higher regard and create a better impression.
The difference in perception stems largely from the fact that incorporated businesses are more rigorously monitored. Limited companies have more complex accounting and reporting requirements, their statutory compliance obligations are much greater, and their corporate details and accounts are published on public record where they can be inspected by other businesses and members of the general public.
A more professional image, coupled with the benefits of corporate transparency, could also benefit your business in many other ways, such as:
- attracting new clients and investors
- accessing a wider range of lending opportunities
- expanding into different locations or markets
- creating a valuable and trusted brand identity
- competing on an even playing field with other businesses in your industry sector
3. Tax efficiency and planning
Limited companies in the UK pay 19-25% Corporation Tax on profits, whereas sole traders pay 20-45% Income Tax on their profits. These lower rates for companies offer greater flexibility for tax planning.
Reinvesting surplus cash
Rather than withdrawing all available profits each year and paying more personal tax on top of your Corporation Tax liability, you can retain surplus income in the business to pay for future operational costs and growth.
This makes more sense than withdrawing all profits, paying higher rates of Income Tax, and reinvesting your own finances when the business needs additional capital.
Deferring personal income
You can defer the withdrawal of profits to a later tax year when a lower rate of business or personal tax would be due. This is an efficient strategy if the withdrawal of all available profits would take you into a higher Income Tax band or Dividend Tax bracket.
4. Higher personal remuneration
By setting up a company, you can reduce your Income Tax and National Insurance contributions (NIC) by taking a combination of a salary and dividends.
If you keep your director’s salary below the NIC primary threshold, you won’t have to pay any Income Tax or employee Class 1 National Insurance on those earnings.
Furthermore, the company won’t have any Corporation Tax liability on the salary because wages are a tax-deductible business expense.
You can take the rest of your income as dividends, which are paid from profits after the deduction of Corporation Tax. You will benefit from the annual £1,000 dividend allowance (2023/24 tax year), so you won’t pay any personal tax on the first £1,000 of dividend income.
Above this sum, you will be required to pay dividend tax. However, dividend tax rates are much lower than Income Tax rates.
Depending on your annual profits, you could save thousands of pounds in personal tax every year by operating as a limited company rather than a sole trader.
5. Separate legal identity
Unlike the sole trader structure, a limited company is a legal ‘person’ in its own right, with an entirely separate identity from its owners and directors. As a result, companies can enter into contracts in their own name and are responsible for their own debts and liabilities.
The owners are only liable for the value of their unpaid shares or personal guarantees, rather than the full extent of the company’s liabilities. If a company becomes insolvent, it is the business itself that is declared bankrupt, not the shareholders or directors.
Furthermore, this means that companies enjoy perpetual succession and survive the death or ownership of the original members. The business can be sold or transferred to other people at any time, thus enabling the company to continue to exist with minimal disruption to clients and employees.
6. Credibility and trust
The professional status of a limited company structure will add valuable prestige and credibility to your business. In fact, certain businesses and agencies (particularly in the IT, finance, and construction industries) are only prepared to engage with other incorporated businesses. This is usually due to the level of risk involved in the contracts they award.
If you’re likely to be dealing with sensitive information, complex IT projects, or large-scale construction contracts, for example, your clients will demand limited liability protection from all contractors because the associated risk of such work is particularly high.
In most cases, sole traders are simply not considered for these types of contracts, so a company really can improve your competitive advantage.
7. Investment and lending opportunities
Companies can have multiple owners, so it is possible to raise additional capital by selling portions (‘shares’) in the business to new investors. Generally, companies also have access to more lending opportunities than sole traders, and certain banks will only lend to incorporated businesses.
Furthermore, it is often possible to secure a loan for a company without the need for shareholders or directors to provide security against their own property.
8. Protecting a company name
All company names must be entirely unique, so no two companies can be set up with the same name, or even names that are very similar to one another. The official name of your company cannot be registered and used by any other business. A sole trader’s business name does not enjoy this protection.
Companies provide the opportunity to invest pre-tax trading income in a company pension scheme, as opposed to investing withdrawn income in a personal pension after the deduction of business tax and personal tax.
10. Splitting income
If you own a limited by shares company, you can issue shares to your spouse or family members. This will allow you to split your business profits and minimise personal tax liabilities.
By issuing dividends to your spouse or children, for example, you can take advantage of their tax-free Personal Allowance, basic tax rate, and the £1,000 tax-free dividend allowance. This is incredibly beneficial if you are the sole or main wage earner and/or you regularly provide financial support to your children.
Disadvantages of a limited company
There are some less favourable aspects associated with limited company formation, as one would expect from anything that provides so many benefits. However, most of these perceived disadvantages pale in comparison to the tax advantages, enhanced professional image, and limited liability protection you will enjoy.
The most notable disadvantages are as follows:
- limited companies must be incorporated at Companies House
- you will be required to pay an incorporation fee to Companies House
- company names are subject to certain restrictions
- you cannot set up a limited company if you are an undischarged bankrupt or a disqualified director
- personal and corporate information will be disclosed on public record
- accounting requirements are more complex and time-consuming
- you may need to appoint an accountant to help you with your tax affairs
- strict procedures must be followed when withdrawing money from the business
- a confirmation statement and annual accounts must be filed at Companies House each year
- a Company Tax Return and annual accounts must be delivered to HMRC every year.
- companies are required to adhere to strict record-keeping requirements, including taking minutes of meetings and recording all decisions taken by directors and shareholders
- company registers and records must be maintained and made available for public inspection at your registered office
- if you make any changes to your company details, you must notify Companies House immediately
About sole trader businesses
Setting up as a sole trader is one of the easiest things to do in terms of registration and administrative requirements. However, there is no legal distinction between the business and the sole trader.
This means that you would be wholly and personally responsible for all business debts and liabilities. Your home and other assets would be at risk if you were unable to meet your financial obligations or if legal action was taken against the business.
On the flip side, because there is no legal distinction between your personal finances and business finances, there is no need to go through any complex procedures to remove money for personal use.
Pros and cons of the sole trader structure
The sole trader structure is ideal for many small business owners, particularly freelancers who have only a few clients and/or earn less than around £30,000 a year.
However, there may come a time when it is financially or professionally beneficial to consider limited company formation. If you reach that point, your first port of call should be an accountant who can advise on the best course of action.
|Quick and easy to set up online and no need to register with Companies House||Unlimited personal liability for debts and legal claims|
|No need to pay a registration fee to HMRC||More challenging to raise capital and acquire loans|
|Typically low startup costs and expenses||Can only be set up and owned by one person|
|Easy to remove profits for personal use||Required to pay Income Tax between 20-45%|
|Minimal accounting costs and requirements||You will be responsible for paying your own tax and NIC|
|You will own all business profits and assets||Many firms refuse to do business with sole traders|
|No requirement to disclose accounts or personal details on public record||Not eligible for Statutory Maternity Pay|
|No requirement to make business records available for public inspection||The professional status of sole traders is not as highly regarded as the limited company structure|
|Minimal paperwork and record-keeping requirements||No option to defer withdrawals until a later tax year or reinvest surplus cash without paying tax|
|No need to maintain a registered office address or service address||Pension options are less tax efficient|
|Fewer restrictions when choosing a business name||Unable to issue profits to a spouse or family member as tax-free dividend payments|
Limited company or sole trader?
There is no doubt that company formation will reduce your liability in the event of your business facing financial difficulty. A limited company also offers many tax benefits; there are numerous advantages to having a prestigious professional image and status; and, you can set up a company for non-profit or charitable purposes.
The benefits must, however, be weighed against the additional time and money required for the additional administration and accounting requirements you will have to deal with.
It’s free to set up as a sole trader, and there is very little administration associated with running this type of business. This makes it the perfect structure for many freelancers and small business owners who are just starting out, have very few clients, and/or generate annual profits below a certain amount.
To choose the best structure for your business, your decision should be based upon your own personal preferences, in addition to professional, tailored advice from an accountant or advisor who has a clear understanding of your business objectives and long-term plans.
Self Assessment for company directors & sole traders
Sole traders (and company directors who receive remuneration other than a salary through PAYE) must register for Self Assessment by 5th October after the end of the tax year being reported in the tax return. For the current 2023/24 tax year, you must remember to register by 5th October 2024.
You can do this in a matter of minutes by providing the following details online for HMRC:
- National Insurance Number
- Your full name, address, and contact details
- Details about the business (name, address, start-date of trading activities, nature of activities)
After registering for Self Assessment, HMRC will send a letter to your contact address. This will contain your personal Unique Taxpayer Reference (UTR) and information about your tax obligations and filing responsibilities.
Filing and payment deadlines for Self Assessment (2023/24 tax year)
The tax year for Self Assessment runs from 6th April to 5th April the following year. Therefore, the current tax year began on 6th April 2023 and will end on 5th April 2024. You can file your tax returns by post or online, and you can pay your Income Tax and National Insurance contributions electronically.
- Paper tax returns must be received by midnight 31st October 2024
- Online returns must be filed by midnight 31st January 2025
- Income Tax and National Insurance must be paid in full by midnight 31st January 2025
You must send a tax return even if you do not have any tax to pay. If you miss the final filing deadline by more than 3 months, you will receive a £100 penalty. However, this fine may be waived if you make an appeal to HMRC. If you are late paying some or all of your tax, you may be charged a percentage of the outstanding balance.