Sole Trader or Limited Company: when is it time to make the change?

POSTED: 8th July 2015
IN: Guides

For many small business owners, it can be difficult to decide whether to continue as a sole trader or become a limited company.

undefinedSome sole traders find that becoming a limited company is a natural part of their business’ progression. However, in order to ensure that it is financially worthwhile, it’s vital that a number of considerations are taken into account.

Indeed, while a business owner may decide to become a limited company to increase their take home pay, separate their finances and build their customer base – they may also find themselves subject to more rules and regulations once they’ve made the transition.


Many sole traders decide to become a limited company in order to separate their personal financial liability from the business.

To illustrate, a sole trader’s finances are inextricably linked with their business, but when a company becomes limited, it has financial independence from its stakeholders. Therefore, should the business encounter any periods of debt, they don’t impact on the owner’s personal financial wellbeing. As a result, any personal assets such as property or savings are protected in the event of business difficulties. 


One of the primary differences between sole traders and limited companies is the way in which they are taxed. A limited company pays tax separately from its owners and directors, while sole traders are taxed alongside their business.

A limited company will pay corporation tax at 20 per cent of its profits. Deductions may be available in the form of tax credits or reliefs, meaning that eligible companies may be not have to pay as much tax. Business owners will also be taxed at the appropriate income tax rate for their salary.

Sole traders will have tax deducted from their business profits once their expenses have been taken into account. They will have to pay 40 per cent on their taxable income if it exceeds £31,785. If their income is over £150,000, they will pay 45 per cent.

Although a sole trader would be able to keep all their business profits once tax has been paid, they may find that their business is more profitable as a limited company due to the lower tax bands. This does depend on individual circumstances so it could be beneficial to contact a registered accountant for advice.


Limited companies can choose to carry losses forward and set them against future profits or factor them into the previous year’s profits. Sole traders can do the same, but can also set losses off against income in the tax year if that’s preferred.

National Insurance

In a limited company, both employers and employees must pay National Insurance on salaries and bonuses.

Sole traders pay less National Insurance than those within a limited company. This will be split into one of two categories:

  • Class 2 if profits are £5,965 or more each year
  • Class 4 if profits are £8,060 or more each year

Sole traders in Class 2 pay £2.80 per week. Those in Class 4 pay nine per cent on profits between £8,060 and £42,385 and 2 per cent on profits over £42,385.

Filing Accounts

At the end of each financial year, a limited company must prepare annual accounts for the company’s records and file these with HMRC as part of the tax return. This should also be sent to shareholders and Companies House.

Sole traders are not legally required to have annual accounts for inspection. However, all business expenses and income details are required for tax return purposes.


Some freelancers choose to become a limited company in order to attract more custom and improve the perception of their business.

Limited companies may also find that mortgage and business finance providers are able to offer them a wider choice of deals than they would if they were a sole trader.

However, once a business owner has made the move from sole trader to limited company, they can no longer withdraw money from the business without formally recording it as a salary, dividend or loan. For some, this may prove problematic, but for others the increased security offered in the form of separate finances can prove a strong incentive to make the transition. Individuals may also benefit from a strengthened customer base once they begin to trade as a limited company.  

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