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Introduction

When deciding to set up a business one of the key decisions is whether to form a limited company or start as a sole trader. There are many factors to consider which can offer advantages and disadvantages of each structure.

Sole Trade A sole trader is an individual in business who is personally responsible for the debts and liabilities of that business. It is the simplest form of business type. It is the business which is owned by only one person. Being a sole trader is the simplest way to run a business: it does not involve paying any registration fees, keeping records and accounts is straightforward, and you get to keep all the profits. However, you are personally liable for any debts that your business runs up, which make this a risky option for businesses that need a lot of investment. Limited Company A limited company takes on a separate legal existence from the individual shareholders (owners) and directors. The share holders are only personally responsible for the debts and liabilities of the company to the extent of their unpaid share capital. The personal assets of directors or shareholders cannot be seized to pay off company debts (with the exception of extreme cases where directors are considered to have been trading recklessly).

1.0 Differences between a Sole Trade and A Limited Company


1.1 Status of Entity A limited company, once properly formed, is regarded as a legal person in its own right totally separate from the shareholders of that business, it can own assets and enter into contracts in aits name. Cleary, if a limited company itself and has no recourse to be shareholders of the business. A sole traders business is not separate legal entity from the sole trader as a person. The businesss debts are legally those of the sole trader. He must sue or be sued in his own nam. He pays income tax on the profits of the business; the business does not pay tax, because it is not a separate entity for revenue law purpose. The same applies to partnerships, except that the partner and severally liable for all debts of the business, which is still not a separate entity from them. However, a company is a separate legal entity. It can sue and he sued, has perpetual succession (although ownership may change) and is taxed.

1.2 Legal Liability One of the differences between a sole trader and a limited company is liability. A sole trader has unlimited liability, meaning that the proprietor is fully liable for the companys debts. This can mean that their own personal wealth is at risk if the business is unable to pay off these debts. The owners of a limited company are the shareholders. They have limited liability, meaning that they can only lose the amount that they have invested in the business, i.e. the shares they have paid for, and no personal wealth can be lost other than this. This is on the assumption that no additional personal guarantees have been provided.

A sole trader (or sole proprietor) business is one which is fully owned by one individual. Although the owner can employ other staff, the owner retains full responsibility and ownership for the business.

Generally speaking sole traders adopt a trading name (doing business as) and therefore the business has no separate legal existence. As a result, the sole trader i.e. the owner, although entitled to receive all of the Nett income, is also personally liable for the debts of the business. This is referred to as unlimited liability.

Limited company directors have more legal, financial and administrative responsibilities, whereas sole traders have an easier life when it comes to paperwork. A limited company is owned by its shareholders.

If things go wrong and a limited company fails, its directors and shareholders have 'limited liability' in that their personal assets cannot be touched. For sole traders, their personal liability is unlimited. A Private Limited Company cannot offer shares for sale on the stock market, whereas a Public Limited Company can. All limited
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companies must be registered at Companies House. All limited companies should submit an 'Annual Return' to Companies House each year as well as their annual accounts.

In legal terms, a company is treated as an individual entity separate from its shareholders. That is why a company pays its own taxes, maintains its own accounts etc. The shareholders of a company are merely owners of small or large bits of the company. That is why they are considered separate from the company. A Limited Liability Company or LLC is a legally formed company which has a limited liability for the owners.

The term Limited Liability means that the member or shareholders financial liability is limited to the amount of his investment in the company. Thus, he is not personally liable for the debts of the company. The only amount that he is liable to pay is the amount he has invested in the company i.e. - the amount for the shares he is holding.

1.3 Continuity of Entity The life of a sole trader is very uncertain. Business may close down on the death, lunacy or insolvency of the sole proprietor or any partner. Continuity of business is always at stake. A sole entity might come to an end if the owner becomes bankrupt, retired or has an untimely demise, with no one to look after the business. Limited companies are separate legal entities in their own right and meaning one can continue forever despite changes in ownership or management. Continuity of life of limited company essentially means perpetual continuation without regard to the withdrawal, expulsion, or death of any member. Limited company will not provide for the dissolution of a company upon the bankruptcy, death, disability, or withdrawal of a member. The company does not cease to exist because a director or shareholder dies. No single person owns the company. It has a perpetual existence, which is not affected by the death of any shareholder or director.

1.4 Taxation The tax benefits are often some of the greatest benefits from forming and trading through a limited company compared to a sole trader. The tax rate on dividends and the use of sensible payroll planning often mean that the business owner(s) can make substantial tax savings. This obviously needs to be set against the greater administrative costs, however usually there will still be a net benefit. Although a company pays corporation tax on it's profits and each employee/shareholder must pay tax on salaries/dividends, there can be tax savings to be made by using a limited company. The lower rate of income tax on dividends means that owners/managers can often extract profits without paying additional income tax.

For sole traders all income is assessable for tax and so they are taxed on their business profits, in addition to any other sources of income. There is little or no flexibility for deferring some of those profits to another year if you happen to have a particularly good year and are taxed at the higher rate.

Limited Companies are taxed on their trading profits also, in addition to other sources of income such as interest and rent. Corporation tax is assessed after any owners salary and dividends have been deducted. It is possible therefore to adjust the amount taken from the company in any one tax year, as well as the way in which it is taken out. Some profits can be retained in the company if the owner would otherwise be likely to pay higher rate tax personally.

Under the limited company business structure, your company and personal finances are kept separate, unlike the sole trader structure. Limited companies are

subjected to corporation tax on their profits, whereas sole traders are taxed under the self assessment system.

1.5 Structure of Organisation Sole trader is a person who carries out the trade or business single handedly. He is the whole and soul of the business. Usually, there is no one to assist him; though in some cases he might keep an assistant or a helper.

A limited liability company with several members is considered as a Partnership for the purposes of taxation by the Government. This ensures that double taxation is avoided. An LLC can have an unlimited number of members. An LLC has a lot of flexibility in terms of management. The owners can manage the company themselves, or hire someone to do the job. However, an LLC does need an Operating Agreement to clarify how and by whom the company will be managed.

In effect, this form of company is a combination of a corporation and a partnership. It gives the shareholders a tax advantage, and provides them with flexibility in creating a management hierarchy for business purposes. At the same time, their liability is limited. This also ensures that the risk of each shareholder is limited.

This type of company is prevalent in almost all parts of the world. Most organizations opt for this company type to ensure that their personal financial position is not threatened or imposed upon for the purposes of the company. When the shares of a company are partly paid, even then the shareholders are liable for the entire value of the share.

1.6 Ease and Costs of Formation There is less formality and few legal restrictions associated with establishing yourself as a sole trader. One can start almost immediately. There are no complex forms to complete and no documentation required between the owner and any other party. All he need to do is to inform the Inland Revenue for income tax and National Insurance contribution purposes. If you are providing financial advice or operating a form of employment agency you will also need a government licence. There are no partnership or corporate agreements required by the owner because he is the sole owner. Legal fees are reduced accordingly.

Limited company needs the higher level. Company must be registered at Companies House. Annual accounts must be filed at Companies House. Annual Return must be completed each year to update Companies House with basic details relating to the company. It also requires a small annual fee. Anyone employed by the company must pay income tax and national insurance on their income. The accountancy costs will increase in setting up limited company. The company will be regulating by Companies House, which has strict rules for reporting trading accounts.

1.7 Ownership and Control The sole trader does not have to share the profits with anyone. The profits generated by the business belong to one person. The sole owner decides how and when the money will come out of the business.

The limited company is not limited in the number of people who can take part in the ownership. Ownership of a limited company can easily be changed by a trader of shares. Also all owners can be active in the day-to-day operation. The directors, in consultation with the shareholders, take the decisions pertaining to the company. Meetings such as AGMs [Annual General Meeting] are help to discuss about future stratefies and growth plans. No single person owns the company.

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1.8 The Account System Sole trader basic accounts can be quite simple as a formal accounting system is not required and can be reduced to simple lists of income and expenditure supported by documentary evidence of sales and purchase invoices, effectively single entry bookkeeping. Producing a balance sheet is optional. Due to the simplicity then an accountant may not be required saving a significant cost. Ltd company accounts have to use double entry bookkeeping to produce the year end accounts including a balance sheet with statutory notes and statements. Unless accounting software is employed to produce the company accounts in this format then accounting knowledge is required and an accountants fee may well be in the region of 500 to 1,000. An accountant is not essential for a small pvt ltd company but is the normal approach and offsets some of the tax advantages. Lower corporation tax offered a private limited company advantages over self employment in recent years. The 10,000 tax free limit was cancelled several years ago. Corporation tax rates have increased from 20 per cent to 22 per cent for small ltd companies over the last three years compared with the basic rate tax for a sole trader which has reduced from 22 per cent to 20 per cent Incorporation does still offer tax saving advantages dependent upon the net profit before tax. The private limited company advantages come from the flexibility of being able to determine the proportions of salary and dividends taken compared with a sole trader whose basic accounts are subject to tax at fixed tax rates and thresholds. A sole trader receives a 6,035 personal allowance and pays basic rate tax of 20 per cent on the next 34,800 of earnings up to the higher threshold limit and 40 per

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cent tax thereafter. Class 4 national insurance is 8 per cent of earnings up to the upper primary threshold and 1 per cent thereafter. Dividends are taxed at 10 per cent on total income up to the higher threshold and 32.5 per cent above. The dividend is a distribution of company profit after corporation tax has been deducted and so the shareholder also receives a dividend tax credit from the pvt ltd company of 10 per cent. There are significant private limited company advantages regarding tax liability compared to a sole trader where net income is below the upper earnings threshold. For example assuming the limited company net profit before salary is 35,000. A sole trader would pay income tax of 5,793 plus national insurance of 2,317.20, a total of 8,107.20. If a salary of 6.035 is taken and the rest is taken in dividends a private limited company would pay 6,372.30 corporation tax, after deducting the salary from net taxable profit and the sole trader now the shareholder would pay no income tax. The advantages increase where net taxable profit is above the self employment upper earnings limit as money can be left in the business and therefore only subject to the 22 per cent corporation tax rate thereby avoiding the sole trader 40 per cent tax rate. Another possibility is to distribute the shares among family members to reduce the risk of 40 per cent tax.

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1.9 Additional Financial Considerations Because a director is also officially an employee of the pvt ltd company this gives rise to a number of considerations in determining the extent of a private limited company advantages. Pension contributions of a sole trader are personal and while may be deducted from the personal income liability do not form part of the basic accounts. The pension costs including any company contribution to a pension scheme by a private limited company is a deductible business expense as an employee cost. Using a car for business purposes may have an impact. The sole trader basic accounts would include the business proportion of the vehicle running costs or the mileage allowance. If that vehicle is used by a director then that director is receiving a taxable benefit potentially resulting in a higher tax burden depending upon the type of vehicle as taxable benefits vary. An alternative may be to leave the company vehicle privately owned and the director claim mileage allowances rather than vehicle running costs. Potentially small issues but there differences in the accounting treatment of deductible expenses such as charitable donations, entertaining expenses and use of home as office. A private limited company advantages consist of being able to claim such expenses as valid business expenses which would not be claimable in the sole trader basic accounts as treated as personal not business. If the director and main shareholder have other associated companies then the corporation basic tax rate could be affected.

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1. 10 Administration, Management and Business Standing A sole trader basically pleases themselves with regard to the administration and management of the business. A company director is responsible for adhering to company administration according to statutory regulations in regard to both the limited company accounts, statutory books and management as stated in the articles of association. The duties of a director are more formal than a sole trader. Forming a private limited company is an indication that a business is both serious, has a long term objective and is correctly managed. This psychological perception can increase the business standing of a business. In addition funding requirements are more likely to be met as the lender to a sole trader has to consider the absence of a balance sheet statement in the basic accounts and the financial influences personally affecting the sole trader. A private limited company advantages concern the published financial statements, protection of the financial position from personal influences and the option of increasing security by virtue of asking directors to provide additional personal guarantees. A private limited company advantages over self employment also extends to long term finance. Companies tend to retain more funds within the business to meet future financial commitments which aids year on year growth, a more sustainable business and medium term profits growth over a sole trader.

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2.0 The Advantages of Limited Company

First and foremost, the principal benefit of trading via a limited company has always been the limited liability bestowed upon the company's officers and shareholders. As a sole trader or other non-limited business, personal assets can be at risk in the event of a failure of the business, but this is not the case for a limited company.

As long as the business is operated legally and within the terms of the Companies Act, directors or shareholders personal assets are not at risk in the event of a winding up or receivership. As often happens such events are not always under our own control.

Operating as a limited company often gives suppliers and customers a sense of confidence in a business. Larger organisations in particular will prefer not to deal with non-limited businesses

Many of the costs associated with managing and operating a limited company are no longer much more than with a non-limited business. Accountants and other professional advisers often have conflicting views on when they consider the benefits of being limited to outweigh the advantages of being self-employed. In general terms, at least from the perspective of taxation and accountancy, changes to legislation over the last few years have meant much lower costs associated with limited companies.

There is no obligation for a limited company to commence trading within any set time period after its incorporation. This means that the formation of a limited company is one simple and low cost method to protect a business name. Whilst this
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does not in itself give any rights to use of the business name, many clients incorporate companies in anticipation of future development of new businesses or in order to protect the limited company name of an existing non-limited business for the future. No two limited companies can exist with exactly the same name.

If a limited company becomes insolvent and is wound up only the assets of the Company are used to try to clear its debts. The Officers of the Company have no personal liabilities, and are not made bankrupt, and are free to incorporate another company. However, the shareholders are liable only to the extent of any unpaid shares held.

By contrast, if you trade as a partnership or as an individual, the creditors can claim on all your property to satisfy the debts, and if this is insufficient you may be declared bankrupt. An undercharged bankrupt is forbidden to start another business or to become a director of a limited company.

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2.1 The Disadvantages of Limited Company Its more costly both in terms of time and money to trade as a limited company. First up, you have to pay to form your limited company. If you do it yourself, it can be as low as 20, but if you get someone to do it on your behalf, it can be as much more.

You have to keep proper accounting records (but of course, you would be doing that as a sole trader!), but with a limited company, you will have to provide a set of end of year accounts to Companies House.

Other people, including your competitors can see your accounts and other information that you are obligated to file at Companies House. If you are over the audit threshold, you will also have to pay to have an audit. If you are looking for finance, lenders may ask for personal guarantees, possibly with your house as collateral. You will have to deal with Corporation Tax as well as your personal tax situation.

Even though an L.L.C. sounds like the best possible entity for business purposes, it does indeed have disadvantages. Restrictive Transfer of Ownership: some jurisdictions can complicate how shares in an L.L.C are transferred and because of this most outside investors try to stay away from L.L.C.s and often require firms to change their corporate structure before venture or angel capital is invested. The duration of a limited liability company can end with the withdrawal of one member. L.L.C's are a newer form of a business entity and not all lawyers are aware how they work and they do not have all the various boilerplate forms and contracts for these entities, which can ultimately result in somewhat higher legal fees.

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3.0 Limited Liability First and foremost, the principal benefit of trading via a limited company has always been the limited liability bestowed upon the company's officers and shareholders. As a sole trader or other non-limited business, personal assets can be at risk in the event of a failure of the business, but this is not the case for a limited company.

As long as the business is operated legally and within the terms of the Companies Act, directors or shareholders personal assets are not at risk in the event of a winding up or receivership. As often happens such events are not always under our own control.

Operating as a limited company often gives suppliers and customers a sense of confidence in a business. Larger organisations in particular will prefer not to deal with non-limited businesses

Many of the costs associated with managing and operating a limited company are no longer much more than with a non-limited business. Accountants and other professional advisers often have conflicting views on when they consider the benefits of being limited to outweigh the advantages of being self-employed. In general terms, at least from the perspective of taxation and accountancy, changes to legislation over the last few years have meant much lower costs associated with limited companies.

There is no obligation for a limited company to commence trading within any set time period after its incorporation. This means that the formation of a limited company is one simple and low cost method to protect a business name. Whilst this
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does not in itself give any rights to use of the business name, many clients incorporate companies in anticipation of future development of new businesses or in order to protect the limited company name of an existing non-limited business for the future. No two limited companies can exist with exactly the same name.

If a limited company becomes insolvent and is wound up only the assets of the Company are used to try to clear its debts. The Officers of the Company have no personal liabilities, and are not made bankrupt, and are free to incorporate another company. However, the shareholders are liable only to the extent of any unpaid shares held.

By contrast, if you trade as a partnership or as an individual, the creditors can claim on all your property to satisfy the debts, and if this is insufficient you may be declared bankrupt. An undercharged bankrupt is forbidden to start another business or to become a director of a limited company.

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References
en.wikipedia.org/wiki/Limited_company www.ukcorporator.co.uk/ http://EzineArticles.com/?expert=Henry_F_Pikus Pikus, H. F. (2009, October 15). Business & Corporate Law Attorney. Retrieved November 21, 2009, from http://ezinearticles.com/?Business-and-Corporate-Law-Attorney&id=3099307 http://www.highbeam.com/doc/1G1-204976376.html https://www.quickformations.com/ http://sbinformation.about.com/cs/ownership1/a/LLC.htm http://www.businesstown.com/accounting/basic.asp http://my.safaribooksonline.com/ http://tutor2u.net/business/gcse/organisation_sole_trader.htm http://www.bizhelp24.com/business -start-up/sole-trader-or-limited-company-thedifference.html http://www.smallbusinessacct.com/

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