What’s the difference between a sole trader and a limited company?

Author Photo
Sarah Henderson
10 Sep 2021 @ 02:09 pm

This article is for information purposes only and should not be seen as financial advice. You should consult with your accountant or a finance expert for any tax advice.   

One of the big questions for any contractor when they first set up as self-employed is whether you should operate as a sole trader or a limited company. It’s a personal choice that can be motivated by a number of reasons – after all, there are advantages and disadvantages to both. But what is the difference between the two? Whether you’re new to contracting and trying to work out what to set up as, or are a veteran contractor thinking of changing your status, we’ve produced an outline of each, as well as the key differences. 

What is a sole trader? 

In short, a sole trader is someone who is personally responsible for their business, meaning that, legally speaking, you and your business are one entity. It definitely has its perks, the main one being that as the sole owner you get to keep all of your company’s after-tax profits. There is also somewhat less administration to deal with. That being said, there are disadvantages too. As you and your business are one and the same, you are liable for any losses, which means you may have to repay any debts out of your own pocket. You also have sole accountability, with no one to share this with. You can subcontract, but all big decisions are on your shoulders. 

What is a limited company? 

If you choose to operate as a limited company contractor, then this involves setting up a private company through which you offer your services. This means you maintain a separate legal identity to your business, thus keeping your personal finances separate from those of your business. Again, there are positives and negatives. You can pay yourself a mixture of salary and dividends, which can be more tax-efficient. Any and all shareholders have limited liability for losses and debt, so you don’t have personal responsibility and, should you ever wish to stop being a contractor, a limited company affords more opportunity for a clean break. However, there is a lot more administration and you have to deal with much more complex tax requirements. 

What are the differences between the two? 

The key differences between being a sole trader and operating as a limited company include: 

- Incorporate a company – as a limited company contractor, you incorporate your own company, however sole traders do not.

- Pay dividends – being a limited company contractor allows you to pay yourself a mixture of salary and dividends in order to increase tax efficiency. You do not have this option as a sole trader. 

- Keep all after-tax profits – sole traders can keep all after-tax profits, however, limited company contractors are more restricted.

- Pay Corporation Tax – sole traders do not have to deal with Corporation Tax and so save themselves that particular piece of admin.

- Deal with IR35 – another benefit of being a sole trader is that IR35 rules don’t apply, whereas limited company contractors have to consider it in every contract.

- Limited liability – As a limited company contractor, you have limited liability for any losses or debts but, as a sole trader you would be solely responsible and personally liable.

- Work with recruiters – many recruiters only work with limited company contractors, so sole traders can miss out on opportunities here unless they operate through an umbrella company for those assignments. 

Both structures have pros and cons and both have risks associated with them. Some may decide that they don’t want to touch Corporation Tax and IR35 with a bargepole and, as such decide to operate as a sole trader despite the personal liability and arguably less tax efficiency. Others may decide that being able to pay themselves a blend of salary and dividends while enjoying the ability to work with the majority of recruiters is a bigger priority and incorporate their limited company as soon as they possibly can. Ultimately, it’s up to you and what you feel is most appropriate to you and your situation, and you can always change your mind later on. Sole traders can switch to a limited company, while limited company contractors can dissolve their business and become a sole trader.   

Of course, one thing that both types of business have in common is the need for adequate business insurance. When it comes to contractor insurance, the expert team at Kingsbridge can help you, regardless of whether you’re a sole trader or a limited company. Call us on 01242 808 740 or get a quote online


Some example text