Should I set up as a sole trader or limited company? Dave Fishwick replies

I have just set up my consultancy business after a few decades of working in another business. It’s a difficult time, but I am confident I have saved enough and built my network to see me through these difficult times.

However, I am not sure whether I should set up as a sole trader or a limited company. What is the difference between the two?

If I set up as a limited company, should I pay myself in dividends to lower my tax burden? And which is the best to claim expenses on? I will be working from my home office, so my outgoings are smaller.

I’m launching my own consultancy but I’m not sure whether to set up as a sole trader  

Dave Fishwick, This Is Money’s business doctor replies:  There is no universal answer as to whether being a sole trader or a limited company is better. 

The decision depends on factors such as the expected income of the business and your circumstances. Some advice from a qualified accountant should always be sought on any specific accounting issues. 

You mention you have saved up a decent nest egg and have lots of contacts, and I personally think this is a great way to start a business. 

You will have enough money to pay the bills while you get a chance to get to grips with all the initial problems and challenges that you will inevitably face. 

I also like the fact that you are confident in your ability. Confidence and self-belief are incredibly important when starting any business or new challenge in life.

Try not to worry too much about getting everything absolutely perfect from day one. 

As a general guide you should consider starting as a sole trader until you have a better idea of your ongoing level of income. The business should be cheaper to run, and you can always establish a limited company at a later date.

Accounting costs are generally higher in a limited company because there are more regulations to comply with. 

Limited companies are taxed independently of their owner, and there are tax benefits when profits are higher. 

As your income increases, you may find it more cost-efficient to have limited status to avoid the highest rates of income tax which apply to sole traders.

Dividend payments can be a tax-efficient way of drawing money from a limited company, as they’re taxed at a much lower rate.

Generally the expenses that can be claimed when trading as a sole trader or limited company are the same. 

However, extra care may be needed when running a limited company to avoid expenses potentially being counted as benefits-in-kind.

One of the main benefits of being limited is that it protects your personal assets; you only stand to lose your investment in the business. Should the company fail or legal action is taken against it, you shouldn’t be personally liable for the losses from your finances unless you’ve given personal guarantees on loans.

As a sole trader, you and your business are legally the same. You can therefore be held personally liable for any debts and liabilities incurred from the running of your business. This includes taxes, so there is more risk should things go badly.

Some businesses find being limited gives more credibility with clients. It can also be easier to qualify for credit and accounts with financial service providers such as payment providers.

I haven’t quoted any figures here because they’re easily found online, and though they might be correct at the time of writing, they may well change in the upcoming budget.

The tax system is complex enough to navigate without it constantly changing. It would be helpful if the new government could maintain a period of stability so that businesses can plan for the future.

Regular changes to the system add an extra cost burden, particularly on smaller companies.

Small businesses are already at a disadvantage to large corporations who can afford teams of in-house accountants.

High rates of taxation affect small and medium-sized businesses far more as large corporates can use complex accounting systems and move profits offshore, gaining, in my opinion, an unfair competitive advantage.

I think it is vital for the new government to remember that while big corporations are more visible and have a louder voice, sole traders and small businesses are the backbones of the economy. 

Most people employed in the UK are either sole traders or work in small businesses and contribute massively to society.

Good Luck, and let me know how it all goes.