Sole Trader vs Limited Company and off payroll working (IR35)

When starting a business, many people are unsure of the differences between working as a sole trader and setting up a private limited company. This article gives an overview of the differences as well as important considerations such as the off payroll working rules.

Legal liability

As a sole trader, legal liability for your business rests on you personally. All business debts are your debts and your personal assets are not protected. A limited company, however, is considered a legal entity in its own right, so as a shareholder you have ‘limited liability’.

Tax

A sole trader pays tax on profits as a salary and is required to pay Class 2 and Class 4 National Insurance contributions. However, when operating a limited company, there are a number of ways to extract profits which affect the amount of tax payable. Directors’ salaries are taxed by PAYE and attract employers and employees National Insurance contributions. Dividends can be paid to shareholders which are taxed at lower rates than a salary, but these are not a tax deductible expense for the company, so are taken after corporation tax of 19% has been paid.

Accounts and returns

A sole trader submits a self assessment tax return annually, but does not need to file financial statements or other returns to HMRC. There is, however, a requirement to keep accounting records. The director of a limited company must prepare annual accounts and submit a Confirmation Statement annually to confirm details of directors, shareholders and registered business address.

Off payroll working (IR35)

Off payroll working rules can apply to contractors who operate through an intermediary company. An assessment of whether the worker is considered an employee or self employed must be made for tax purposes. From 6 April 2021, medium and large private sector clients who receive services from a worker via an intermediary company are responsible for determining the employment status of the worker. Where the client is a small private sector business, the responsibility remains with the intermediary company to decide the employment status.

It is therefore important for contractors to consider the off payroll working rules before deciding whether to set up a limited company because the intended benefits may be significantly reduced if the off payroll working rules apply.

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