What is a limited company?

There are two primary types of limited company – those limited by shares and limited by guarantee. The first is the most common amongst businesses, while the second is normally for non-profits and charities.

Limited companies are incorporated at Companies House, which means they become their own legal entity. As such, it’s completely separate from the business owner in terms of its finances and liabilities. As an extension of this, the business owner become protected by “limited liability”, which means that they are only responsible for business debts up to the amount of their investments or guarantees for the business.

This is one of the main advantages of becoming a limited company, as sole traders can be responsible for all of the business debts.

Should I become a limited company?

There are a number of advantages to becoming a limited company, but it doesn’t suit everyone. In this blog we cover some of the top reasons for and against incorporating your business. If you’re undecided, then it’s best for you to contact your accountant and see whether making this change would best suit your business.


Advantages of incorporating your business

Switching from being a sole trader to a limited company is called “incorporation”. There are a number of advantages to incorporating your business…

Your business and personal finances will be separate

The main advantage of this is that you’ll have limited liability protection. This means that your personal assets can’t be seized to pay debts, unless you’ve given a personal guarantee to a company creditor. It also means your business will own its own equipment, pay its own bills and incur its own debts – they won’t legally be attributed to you.

Some prefer working with limited companies

You might find customers have more confidence trading with you or awarding you contracts if you’re a limited company. This is usually irrespective of the size of your business as a sole trader or limited company (i.e. a smaller limited company may have more luck than a more established sole trader).

This is often because limited companies are subjected to more rigorous monitoring and reporting in their accounts and elsewhere. Furthermore, limited companies have their details and some account published publicly, meaning it’s easier for potential investors or clients to investigate you.

As a result of this, some companies (particularly IT, finance and construction firms) will only work with other incorporated companies due to the high-risk level involved in their contracts.

You have more options with your post-tax profit

You can choose to pay the money as dividend and pay personal tax, or invest and spend the money. Or you can keep the money into the company and earn interest through your business bank account (avoiding personal tax).

If withdrawing all your profit would result in you paying a higher rate of tax, then you can leave surplus income in your profit and loss reserves to withdraw at a later date. As a sole trader, this isn’t possible as your personal and business profits are indistinguishable.

There are other options too, such as investing it in a pension or leaving it in the company for a capital gain once the business dissolves.

You’ll legally own your business name

Unless you’ve registered your company name, you probably don’t own the rights to your business name as a sole trader. So if someone else sets up a limited company with the same name as your sole trader operation, you could face a legal battle to keep the name.

It might be easier to get investment

As a limited company, you can sell shares to investors. As a sole trader, however, you can only really seek investment if you turn your business into a partnership.

You’ll probably find more opportunities to borrow money as a limited company, as some banks choose to only lend to limited companies. You’ll might also find that you can secure a company loan without shareholders or directors providing security against their own property, as your company is a separate legal identity.

You can learn more about the types of shares you can sell in our guide to incorporating your business, available for free download here.

You might pay less tax

As a limited company, you won’t have to pay Income Tax on account like you do as a sole trader. As a limited company, you’ll pay 20% Corporation Tax on profits (until profits exceed £300,000 a year) and no National Insurance. This is compared to 20-45% Income Tax paid on profits plus Class 4 National Insurance paid as a sole trader.

Please note: limited companies are not entitled to employment allowance, so you’ll only see the tax benefits if your profit is over £50,000 per year.

You might get more tax relief

As limited company, you’ll be able to make more tax relief claims against salaries, pension contributions, accommodation and other areas.

You might end up with more money

If you’re paid through a combination of salary and dividends, then you could reduce your Income Tax and National Insurance Contributions. This is done by keeping your director’s salary below the NIC lower profits limit (£8,164 for the tax year 2017/18).

As you don’t have to pay personal tax on the first £5,000 of dividend income in a tax year, you can take the rest of your income as dividends paid from post-Corporation Tax profit. Above £5k, you’ll have to pay dividend tax, but this is usually lower than Income Tax rates so you might end up better off – depending on your annual profits.

Is incorporating right for my business? Ask an accountant


Disadvantages of incorporating your business

There are some downsides to moving from a sole trader to a limited company, so it’s important to carefully consider whether it’s the right decision for you. Disadvantages can include…

More paperwork

As a sole trader, you’ve only had to file your Self-Assessment tax return each year. As a limited company, you’ll have to file:

  • A set of accounts
  • An annual return
  • A corporation tax return
  • A personal tax return, if you’re the company director

This means you’ll have to spend more time preparing your paperwork. If you’re running the business by yourself, this could prove too demanding on your time.

You might pay more tax

You won’t be able to freely draw money from your business bank account once you’re the director of a limited company. Instead you’d have to pay yourself a salary from the company, pay yourself dividends on shares you own and reimburse yourself for business expenses. If you take any extra money out beyond that, you may have to pay more tax.

Also bear in mind that, as a sole trader, you can use any loss your business makes to save tax on other sources of income – but a limited company can only use its losses against its own profits.

Your tax and accounting may become more complicated

You’ll have to file your accounts with Companies House within 9 months of company’s year-end. The full set of statutory accounts you’ll have to file include:

  • Profit & loss account
  • Balance sheet
  • Director’s report
  • Auditor’s report
  • Notes to the accounts

Though smaller businesses don’t have to submit all of these forms, the increase in paperwork may result in higher accountant fees and admin costs.

You’ll have more legal duties

As a director, you’ll have to safeguard the business’s assets – which can include the decision to cease trading if you know the business won’t survive. Failure to fulfill your duties can result in fines or even a prison sentence.

You’ll have less privacy

As a limited company, your company accounts and Confirmation Statement will be in the public domain. Your office address will also be public domain (though you can use a token address or your accountant’s office if you work from home). Depending on the size and structure of your business, you may not want the details of directors, owners and people with significant control (PSCs) of the business being on public record.


Becoming a limited company

To incorporate your business, you’ll have to register as “limited by shares” or “limited by guarantee” with Companies House.

To learn about the steps involved in moving from a sole trader to becoming a limited company, including who you should contact and the different paperwork you’ll have to file, download our free eBook: Moving from Sole Trader to Limited Company

If you’re looking to simplify bookkeeping for your small business our software could be the perfect solution. Why not take a free trial to see how you can save time and money with KashFlow.

See how IRIS KashFlow works with your business and your books