Company vs. Sole Trader/Partnership: Pros & cons
One of the first major decisions you will have to make as you start your new business is the form of legal entity it will take. To a large degree, this decision may be dictated by the way you have organised your operations and whether you intend to work on your own or in conjunction with others.
The form of entity you choose can have a significant impact on the way you are protected under the law and the way you are affected by taxation rules and regulations. There are four basic forms of business organisation. Each has its own benefits and drawbacks and is treated differently for legal and tax purposes.
We’ve broken down the pros and cons of each legal entity as a general guide. However, to determine the right entity for you, our team will need to look at the specific details of your business.
Company vs. Sole trader/Partnership
| COMPANY | SOLE TRADER/PARTNERSHIP |
| A company must be formally incorporated with a written constitution in the form of a Memorandum and Articles of Incorporation. There is, therefore, an initial setup cost. | There are no formation costs, but a written partnership agreement is advised. |
| Companies are governed by the Companies Acts. A company must: – – Keep accounting records – Have the accounts audited* – File accounts and an Annual Return with the Registrar of Companies. This information is available to the public. – Keep Statutory Books showing details of shareholders and directors *Your company may qualify for an audit exemption if it has at least 2 of the following: An annual turnover of no more than £10.2 millionAssets worth no more than £5.1 million50 or fewer employees on average | Sole traders and partnerships are not required by law to have annual accounts nor to file accounts for inspection. However, annual accounts are necessary for the HM Revenue and Customs tax returns. |
| Companies may have greater borrowing potential. They can use current assets as security by creating a floating charge. | Sole traders and partners are unrestricted in the amount and purpose of borrowings but cannot create floating charges. |
| Shares in a company are generally transferable ownership may change but the business continues. | |
| Incorporation does not guarantee reliability or respectability but gives the impression of a soundly based organisation. Personally, there may be prestige attached to directorship. | The unincorporated business does not carry the same prestige. |
| Tax is payable on directors’ remuneration paid via PAYE on the 19th of the following month. Tax is paid by shareholders on dividends under the self-assessment rules, although the first £2,000 of dividends are tax free each year. Unless profits exceed £1,500,000, corporation tax is payable 9 months after the year-end. | For a sole trader or partnership, tax is generally paid by instalments on the 31 January in the tax year and the 31 July following the tax year. For an ongoing business, the tax for 2022/23 is payable: first payment on account on 31 January 2023, second payment on account on 31 July 2023, with any final balance due on 31 January 2024. For a start-up business, this is slightly different and covered in more detail later in this publication. |
| First year losses in a company can only be carried forward to set against future profits. | Start-up losses generated by a sole trader or a partner in the first four tax years can be set against other income of the year or carried back to the three previous tax years, potentially resulting in a tax refund. |
| The corporation tax rate is currently 19% irrespective of the level of company profits. The main rate will be increased to 25% from 1 April 2023 where profits exceed £250,000 a year. From that date, the 19% rate would only apply to profits up to £50,000 a year with a marginal rate of 26.5% for profits between the two new thresholds. | Profits are taxed at 20% on taxable income up to £37,700 for 2022/23 and 40% thereafter with a 45% rate on income over £150,000. Finance Act 2021 has frozen the personal allowance and income tax thresholds until 2025/26. |
| There is both employers’ and employees’ national insurance payable on directors’ salaries and bonuses. The NI charge is greater than that paid by a sole trader/partner, but there is no NI charge on dividends. There is also a £5,000 (2021/22 £4,000) Employment Allowance to set off against employers NIC although that is not available where the total employers NIC liability exceeds £100,000 and where the director is the only employee. | A partner/sole trader will pay Class 2 NI of £3.15 p.w. (2022/23) and Class 4 NI dependent on the level of profits, 10.25% on profits between £11,908 and £50,270 and 3.25% thereafter. This includes the 1.25% health and social care levy for 2022/23. |
| Where the business owner is both a shareholder and a director, they have a certain amount of flexibility to control their personal tax liability as they only pay tax personally on what they draw out of the company. Many director shareholders pay themselves a low salary to minimise national insurance and extract the bulk of their income by paying themselves dividends. Where they are in receipt of child benefit, they are able to minimise the tax they pay on that income by keeping their income below £50,000. | Sole traders and partners are taxed on their share of business profits irrespective of the amount that they draw out of their business. Consequently, they are less able to control the level of their taxable income compared to a director/shareholder of their own company. |
Count on Cardens
We hope that we have equipped you with the information you need to choose the right legal entity for your business. If you would like further information, please get in touch: 01273 739592
What our clients say
“I was introduced to Barry Carden of Cardens Accountants many years ago. He offered to visit me and check my books at no charge. I was at that time not a limited company and had been trading as such for a very long time. I was advised by my then accountant not to become a limited company.
When Barry visited and checked my books, he said straight away that I should become a limited company and explained why and how it would save me thousands of pounds not hundreds. I have used Cardens accountants ever since and have always found them to be on the ball and helpful.” – Keith Lawton, K E L Building Advisor Limited
