Sigma Accounting:

Sigma Accounting specialises in providing accountancy and business advisory services to owner managed businesses based on the Isle of Man.

For an informal discussion about how we can help you with the accountancy requirements of your business please contact us.

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SIGMA accounting

Sigma Accounting is registered in the Isle of Man (number 023280B)

and is a member of the ICAEW Practice Assurance Scheme.

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Sole trader or limited company?

One of the key decisions when starting your own business is to choose between forming a limited company and setting up as a sole trader. There are other business vehicles such as Partnerships and LLC’s but generally the most suitable structure for a small business will be a Limited company or sole trader.

The reality is that there is no easy answer to the sole trader or limited company question as everyone’s situation is different, and what’s right for one business may not be right for another. There are many factors to take into consideration when making the decision. For example:

• The type of business you are thinking of running

• What kind of administrative support you have, if any

• What your turnover is and how much profit you make

• Your future plans to grow the business, or not

• What level of commercial risk you will be exposed to

• Whether customer perception matters

As with all major business decisions, there advantages and disadvantages to consider, the key features of each structure are outlined below

Sole trader:

A sole trader is a business entity owned and run by one person, where there is no legal distinction between the owner and the business. The individual holds all assets of the business and so acquires all benefits and risks of running the enterprise. This means that the individual risks losing their personal assets if the business fails.

Features of being a sole trader:

• Sole traders have fairly simple accounts and are required to pay tax via the owner’s personal tax return

• Professional accountancy advice is normally required to prepare business accounts, tax returns and administration around VAT and payroll. However, there is less complexity compared with a limited company, which can result in reduced administration costs.

• The set up costs and ongoing statutory filing costs are cheaper for a sole trader than for a limited company.

• Sole traders have unlimited liability; there is no legal distinction between the business and the owner, therefore the owner is personally liable for the business’ debts, which in turn means the owner's personal assets are potentially at risk. When first trading the business may be small and consequently there may be lower exposure to cost and risk, but as the business grows it is likely to become larger and riskier. It is usually much better from a risk perspective to trade through a limited company. This is one of the main issues to consider when deciding on the structure of a new business.

• Because there is no distinction between the business and its owners all the profits of the business are assessed for tax via the owner’s personal tax return. This offers fewer tax planning opportunities than are available to a limited company, but if the business is still small and all of the profits are being taken by the owner anyway it makes little difference.

Limited company:

The fundamental difference between a sole trader and a limited company is that a limited company is a separate legal entity, it is effectively another person.

A company is owned by its shareholders and run by its directors – in a small business the shareholders and directors are usually the same people.

The liability of the shareholders for the debts of the company is limited to the unpaid value of their shares. As most shares are fully paid when they are issued it is rare for the shareholders to be held liable for the company's debt. As long as the directors have complied with the Companies Acts the personal assets of the shareholders are normally safe.

Features of being a limited company:

• An element of prestige is created by forming a limited company. The corporate identity often appears more professional, more established, and both customers and suppliers know that the company is legally registered. This leads to the perception that a limited company is more trustworthy than sole traders.

• Some customers, usually larger companies, will only work with other limited companies which may mean you have to form a limited company

• It will cost more to set up a limited company and the ongoing statutory costs and administrative expenses will be higher than a sole trader to ensure compliance with the formalities of company law.

• Professional accountancy services are normally required to assist with the preparation and filing of accounts and tax returns, and because limited companies are more complex than sole traders accountancy fees are generally more expensive

• Limited companies offer limited liability to the shareholders as the company is a separate legal identity from the owners. Therefore the shareholders normally have no personal liability beyond the amount paid for their shares. For this reason most new businesses are structured as limited companies.

• Better tax planning opportunities; the shareholders of a company only pay tax on the profits of the company when they are extracted. This means that there is a degree of flexibility as to when tax is paid which in turn means that a shareholders allowances and tax bands can potentially be used to better effect.

• There is less privacy for a company than a sole trader. Certain business information must be filed with the Companies Registry and as a result it is available for inspection by members of the public, for example the company's statutory documents, the names of shareholders and directors, and the location of the company’s registered office.