Limited Companies and Sole Traders:
Accounting, Tax and Bookkeeping Differences

Ainsworth Accountants provide a full Year End Accounts preparation and filing service.

We provide a bookkeeping service, either training and helping you, or a full bookkeeping service.

Guide to some differences between limited companies and sole traders, and the consequences for bookkeeping

This webpage describes the differences between sole trader and limited company bookkeeping.

There are a significant number of reasons why bookkeeping, accounting and tax is more complicated for limited companies. The reasons include:

• Limited companies are a separate legal entity to the owners, whereas a sole trader and the business are one and same for legal and tax purposes.

• Limited company Accounts must be filed on public record at Companies House, but sole traders’ Accounts do not.

• Sole trader Accounts need only be a Profit and Loss Account, and for small businesses often only 3 figures are sent to HMRC on the Self Assessment.

• Limited Company Accounts must comprise at least a Profit and Loss Account and a Balance Sheet, and a detailed Profit and Loss Account must be sent to HMRC.

• Sole traders are usually only subject to Income Tax.

• Limited Companies are subject to Corporation Tax, and usually also involve PAYE, and Dividend Tax.

• Sole traders are subject to Class 2 National Insurance and Class 4 National Insurance, based on profits, whilst limited companies are subject to Class 1 National Insurance for the employees, which is not based on profits.

• The regulations for sole trader bookkeeping are governed by HMRC.

• The regulations for limited companies are governed by the law, ie. the Companies Acts, HMRC, internationally agreed regulations, and the Accounting Standards regulated by the accounting professional institutes.

• Limited company Accounts must by law be prepared on the “accruals” basis (please see: Accounting and Bookkeeping), whereas small sole trader businesses have the option of the accruals or cash basis. This means that limited company Accounts need to include bank balances and money owed (debtors and creditors) on the Balance Sheet.

• Sole traders are taxed, under Income Tax, on the business profits, and do not pay themselves a salary.

• Limited companies are taxed by Corporation Tax on the business profits. The director/shareholders of limited companies are personally paid and taxed on salary and dividends. Salaries are an expense deduction when calculating Corporation Tax, but dividends are not.

• Sole traders who use some of their personal assets for the business are allowed in some cases, eg. a car, to assess a percentage to claim as a business expense. Such percentage calculations do not apply to limited company Corporation Tax.

• If a sole trader does not have a separate bank account for the business, an accountant would not necessarily ask to see the personal bank statements. Whereas for a limited company every company bank and credit transaction must be recorded, and the bank reconciliation checked by the accountant.

• A sole trader can take money from the business at any time and this would not affect the business tax calculations. It is very different for a director/shareholder taking money out of the company.

• There are some handy, flexible, yet potentially complicated, options for directors taking money from a company. This would be classed as a director’s loan. The flexibility means that director/shareholders do not need to take ‘penny for penny’ the exact salary and dividend. The Director's Loan Account (DLA) deals with this, along with money that a director puts into a business, and expenses that a director incurs personally on the company’s behalf.

• If limited company bookkeeping is not kept up to date at all times, accountants will be unable to give the correct and timely recommendations for dividends and salary, and carefully monitor the DLA. Incomplete and unbalanced records make the tax strategy more difficult to calculate and implement.

• There are some business expenses which are subject to different rules for sole traders and limited companies. Examples are Travel & Subsistence and Training.

• There are no major differences for VAT. VAT is one area where sole trader and limited company bookkeeping requirements are effectively the same. Just as importantly, the main VAT scheme for limited companies and sole traders is based on the "accruals" principle, but the cash basis is a VAT option for both sole traders and limited companies. Limited companies which use the cash basis for VAT must still use the accruals basis for the Accounts.

Sole traders are used to a relatively straightforward listing of expenses and sales.

Limited companies must record where the money went for the sales. For expenses it is necessary to record where the money came from. These distinctions are important in small family-based limited companies because there is often a cross over between the business and private money which needs to be carefully recorded.

The accruals system means that for all sales and expenses both the sale / purchase date should be recorded as well as the date the money was transacted.

Under the accruals system the tax calculations are based on the date of the sales and purchase invoices, not the date when they were paid.

For all these reasons, careful, accurate up to date bookkeeping records are essential.

Whilst limited companies can have tax and other advantages, the above details will also explain why accounting fees are greater for limited companies.