Sole trader v. limited company: Tax differences & savings (2025/26)

17 Mar 2025

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Sole trader v. limited company: Tax differences & savings (2025/26) Related image

Is it better from both a tax and legal point of view to run your business as a sole trader or as a company? Are there tax advantages in running a business as a company? What legal protections apply?

 

Sole trader

Limited Company

You are 'the business' and its owner.

Your company is a separate legal entity from you, its owner.

If the company is limited by shares, and you hold those shares, you are a shareholder.

As a director you are an officer of the company: you have a fiduciary duty to act in its best interests.

In the event of any legal dispute, you will be sued personally unless you have suitable insurance e.g. products and services liability, professional indemnity, employer's liability, public liability etc.

In the event of any legal dispute, the company will be sued unless it has suitable insurance cover. It is difficult under UK law to sue a director personally for a company's wrongdoing. There are exceptions where the 'corporate veil' may be pierced and a director may be held personally accountable e.g:

Where the director has perpetrated fraud.

Where the director has committed specific offences such as corporate manslaughter or under health and safety legislation, environmental acts, the Companies Act and listing rules.

In tax, in cases of fraud by the directors and for penalties involving deliberate concealment and offences by Senior Accounting Officers of large companies.

A liquidator holds them accountable as a result of insolvency. 

Accounting basis and tax returns

Annual accounts are simple to prepare. Generally Accepted Accounting Practice (GAAP) is followed unless cash accounting is used.

You prepare one tax return under Self Assessment. If you are below the VAT threshold, you may enter a three-line summary of your accounts in the self-employed section of the return. Otherwise, you enter the account details line-by-line version.

You must choose whether to use 'Simple Accounting' cash accounting or accruals accounting and then whether to claim fixed rate expenses for certain items. 

You must make adjustments to change from one accounting basis to another.

If you make errors or mistakes in your tax returns you are personally accountable for them.

Accounting basis and tax returns

Your accounts are prepared in the format specified by the Companies Act, and Generally Accepted Accounting Practice (GAAP), generally under FRS 105 or FRS 102. Software makes this a pretty easy task for most small companies.

HMRC requires you to convert your accounts into a tagged iXBRL format (software does this part for you, but some manual coding may occasionally be required).

As a company is a separate legal entity, it prepares its own tax return and tax computations. You as a director (and possibly shareholder) also prepare a separate return for yourself.

If the company makes errors or mistakes in its tax returns the directors are not generally personally accountable for them unless there is evidence of fraud or wrongdoing, or if the company is large and the director has responsibilities as Senior Accounting Officer.

Employment status

You are self-employed; you cannot be your own employee.

In difficult times, such as the COVID-19 crisis in 2020-22, government support was based on trading profits.

Members of a Limited Liability Partnership who are on fixed profit/no risk arrangements may be automatically classed as employees.

Employment status

A director is an office holder, this does not automatically make you an employee in terms of employment law, the National Minimum Wage or for Tax Credits.

For Income Tax and National Insurance purposes, company officers are treated as employees.

In the COVID-19 crisis in 2020-22, government support for directors was based on their payroll salary.

If the Off-Payroll Working rules apply, fees paid to the company, in respect of its worker's service are taxed under PAYE/NIC by the end client. Your worker is taxed as if being employed directly by the end client. No extra employment rights are created. This is purely a tax measure.

Tax on profits

You pay Class 4 National Insurance Contributions (NICs) and Income Tax on the taxable profits of your business, or your share of profits if you are in partnership. 

Tax on profits

 

Since April 2023, Corporation Tax is paid at different percentages depending on profits. Where the company's profits are: 

<£50,000, the rate of Corporation Tax is 19%. 

>£250,000, the rate of Corporation Tax is 25%.

Between £50,000 and £250,000, the rate of Corporation Tax is 25%, but marginal relief is given.

There are no NICs on company profits.

Losses

You can offset your trading losses against your other income.

There is a cap on the amount of relief that you may claim for losses.

Losses

The company can flexibly offset its trading losses against its other income, but not against your income as an individual shareholder.

Extracting profits

You may withdraw cash from the business without tax effect.

Extracting profits

As a company owner/director, you are taxed on any income withdrawn from the company.

Salary or bonuses are taxable as earnings and subject to PAYE Income Tax and NICs.

If you or your family and household receive a taxable benefit, your family and household are subject to further tax (subject to Tax-free exceptions).

If you are given shares or securities in the company, the difference between the price you pay (if any) and market value is taxable either via PAYE or otherwise under Income Tax Self Assessment.

If the Off-Payroll Working rules apply to a company's contract, fees paid to the company are taxed under PAYE/NIC by the end client.

If IR35 applies to its contracts, the company will receive its income gross but must account for PAYE and NICs on the deemed payment.

Shareholders are subject to Income Tax on any dividends, which must be paid out of distributable reserves; payment follows the formalities of the Companies Act, see Dividend Index. Tax is payable by the recipient with exceptions for dividends paid to other companies and persons offshore.

Capital distributions e.g. a qualifying Purchase of own shares or Capital reduction are taxed as capital.

A disqualifying payment is taxed as income if it falls within the Transactions in Securities rules.

Up to £25,000 may be extracted as a Capital distribution on striking off without concerns about the Transactions in Securities rules or Targeted Anti-Avoidance Rule (TAAR).

Loans: borrowing from your business

You are the business and so any money you extract is yours in any case. You cannot make a loan to yourself.

You are free to borrow from the business bank account, it is your account.

If your business bank runs at an overdraft due to the amount of funds that you have withdrawn personally, tax relief on bank charges and interest may be proportionately restricted.

Loans: borrowing from your business

Borrowing by directors is permitted with limits set by the Companies Act 2006. A tax charge may apply.

The company may make you an interest-free loan of up to £10,000 without a taxable benefit.

Otherwise, if the loan is interest-free or interest is charged below the Official Rate of Interest, there will be a tax charge for the director based on beneficial loan interest.

During 2025-26 the company pays a tax charge of 33.75%  if you borrow from the company, are a shareholder, and do not repay the loan within nine months of the year-end.

Making Tax Digital (MTD)

MTD for Income Tax applies from April 2026 where turnover is >£50,000, and April 2027 where turnover is >£30,000.

A joining date for partnerships is yet to be determined.

Making Tax Digital (MTD)

The introduction date for MTD for Corporation Tax is not currently known.

Private expenses and mixed-use of assets

You must adjust your accounts for tax to exclude items not wholly and exclusively used for the business, and apportion expenses, for tax, if there is mixed-use.

You may claim Fixed-rate allowances for certain expenses where there is mixed use which can give you a small tax advantage.

You may claim capital allowances on mixed-use assets, restricting the capital allowances claimed accordingly.

There can be a tax advantage on claiming mixed use of an asset that is sold as it is pooled separately from other assets and the disposal creates its own balancing event.

Private expenses and mixed-use of assets

You do not need to adjust accounts for private expenses or use of assets, although you may wish to in order to avoid a personal tax charge.

If you incur private expenses via the company, these expenses are either deducted via the payroll from your net salary, or they are offset against any credit balance you have on your directors' loan account. Failing that, you can report the expense as a benefit annually on form P11D, or via the payroll under payrolling arrangements, and then pay tax on the benefit.

Payrolling of benefits becomes mandatory from 6 April 2026.

There are special rules for the private use of assets, see Benefits below.

VAT

It is a 'taxable person' (not a business) that is registered for VAT. This means that if you have two sole trade businesses, you cannot register only one of them for VAT.

You may cash account for VAT, provided that you are within the turnover limits. 

Your turnover for VAT is determined on an invoice basis which can be confusing if you are using the cash accounting scheme for Income Tax and NICs.

You may operate the VAT Flat Rate Scheme, subject to turnover limits, but this may lead to you being caught out if you also make money from any other activity as an individual which would not usually be VATable (rental income etc), or if you sell assets that have had some business use (cars/homes etc).

You must be aware of the Limited cost trader rules if using the Flat Rate Scheme.

If you make Errors or mistakes in your VAT you are personally accountable for them.

VAT

You may cash account for VAT (within the turnover limit). As a company is a separate legal entity it can operate the VAT Flat Rate Scheme (subject to turnover limits) with no effect on any business that you run as an individual. This is subject to anti-avoidance measures if you Artificially split up a business.

The limited cost trader rules should be considered for the Flat Rate Scheme.

As with direct tax, if your company commits VAT fraud, any VAT penalties payable can be transferred to the directors personally.

Income splitting

A sole trader can split their income by joining in business with a partner. The result is that the business is then a partnership. Each partner will then pay tax and NICs on their share of the partnership's profits.

Paying a Salary to a spouse or family members must be commercially justified to be allowable for tax purposes.

Rent

If you own a property personally you may rent it to your company. This includes granting a licence to your company for non-exclusive* use of part of your home if you operate from there.

You will need to account for the rental income, less your expenses in providing the property on your personal tax return.

*to preserve CGT Private Residence Relief (PRR)

The restriction in interest tax relief for landlords applies to directors who rent out their own property to their companies and then claim tax relief on their finance costs against that income.

Benefits

You do not have any special rules for benefits as personal expenses or personal use of assets are disallowed for tax.

Tax-free benefits

As an employee of your own company, you may receive a large range of tax-free benefits.

Top benefits for 2025-26 are electric vehicles which carry a very low Benefit In Kind.

Exempt benefits include equipment such as a phone, laptop, pensions advice, and parties.

Directors and members of their families have a cap on £300 of trivial benefits.

Other benefits

As a director, you are taxed as an employee and subject to tax if you receive taxable benefits.

There are different rules to tax different types of assets, for example, cars and vans have set Benefit In Kind charges and there are special rules also where the benefit is accommodation, an interest-free loan in excess of £10,000 and where the benefits are shares and securities.

For other assets, your annual benefit is calculated at 20% of the cost of the asset (inc VAT).

Special rules

As sole traders are taxed transparently, 'you are the business', there is generally no need to have special rules.

Construction Industry Scheme (CIS):
If you are a subcontractor and within CIS, you will suffer tax deduction at source unless you have a gross payment certificate. If you are a contractor within CIS, you have an obligation to withhold CIS tax from your subcontractors and report payments to HMRC. 

Disguised remuneration:
These rules apply to self-employed contractors receiving loans from third parties instead of trading receipts.

Special rules

A range of different, mainly anti-avoidance, rules may be applicable to companies and their owners. These include:

Construction Industry Scheme:
If the company is a subcontractor and within CIS, it will suffer tax deduction at source unless it has a gross payment certificate. If it is a contractor within CIS, it has an obligation to withhold CIS tax from its subcontractors and report payments to HMRC. 

IR35:
If you run a personal service company you are required to self-assess to determine whether you are a deemed worker of your end client. 

There are special rules for Personal Service Companies & tax under Off-Payroll Working.

Managed Service Companies (MSC):
Rules to prevent companies avoiding IR35 through the use of contracts via an MSC.

Employment intermediaries:
If you are employing workers from overseas or agency workers you are obliged to deduct PAYE. If you fail to you must report quarterly to HMRC.

Employment-related securities:
If you give shares to a director or employee at less than market value outside of an approved share scheme the ERS rules will tax the value of the benefit received.

Close company transfers of value:
If you change the value of the company so that your shares are worth less in your estate for IHT purposes this may well be a transfer of value and a charge to IHT may apply.

Disguised remuneration:
These rules are designed to prevent the disguising of remuneration by extracting profits as loans via third parties such as EBTs. On 5 April 2019, all outstanding loans were subject to the loan charge unless they were taken after 9 December 2010, or April 2016 in certain limited circumstances. Loans could be spread across three tax years by election.

Passing on the business

A sale or gift of a sole trade business will be a disposal for CGT purposes. 

The incorporation of a sole trade will also be a disposal for CGT purposes.

CGT Business Asset Disposal Relief (BADR) is not available on the disposal of the goodwill of a sole trade on incorporation.

Some care is required to ensure that the disposal of assets used in the business can qualify for BADR. 

From 11 March 2020, the lifetime allowance for BADR is reduced to £1 million for all types of disposal. 

Retiring: passing on the business

The company's assets or shares may be sold.

If there is an asset sale, there is potentially double taxation: the company will pay tax on its gain (the indexation allowance is available for assets owned before 1/1/2018) and its owners will pay tax when they extract the remaining funds from the company.

A company may Purchase its own shares), back from a shareholder (there must be a trade benefit).

Shares can be sold to a third party, or by employee buyout.

A qualifying disposal of a majority interest to an all-Employee-owned trust is exempt from CGT.

CGT Business Asset Disposal Relief (BADR), will apply on the disposal of shares in an individual's trading company, provided that qualifying conditions are met.

BDAR is subject to a lifetime limit of £1 million for all types of disposal.

BADR can also apply on an associated disposal of land and property used by an individual's company, provided that the individual is making a disposal of their shares, no rent was paid for the use of the asset, and the land/property is sold within a qualifying period.

Death

A trade or business:

When you die your business ceases. You can pass all or part of it under your Will.

In a partnership, you can pass on your share of the partnership.

Business Property Relief (BPR) may apply for Inheritance Tax (IHT) purposes if the business is a qualifying trade.

An investment business:

There is no IHT relief on disposal of an investment 'business' of a sole trader, however their individual investments, for example, shares in an AIMs company may qualify for IHT relief

Death

When you die the company lives on: it is a separate legal entity.

For a trade or business where the activities are not wholly or mainly investment activities, the company’s shares should qualify for Business Property Relief (BPR) for IHT purposes.

For a company whose business is wholly or mainly investment activities, including land and property, there is no IHT relief.

Assets held outside of the company for its use:

There is no IHT relief on outstanding directors’ loans.

Assets such as land and property that are held outside the business can qualify for 50% BPR.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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