What are the tax differences between a sole trader and a limited company?

Based on the sources gathered, here is a comprehensive comparison of the key tax differences between a sole trader and a limited company.

Tax Differences: Sole Trader vs Limited Company

What the law says

Type of tax charged on profits

The fundamental distinction is the type of tax that applies to business profits:

• A sole trader is subject to income tax on their trading profits under the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005). They are "subject to taxation under [ITTOIA] 2005" and are "entitled to all the profits of the business."

• A limited company is a separate legal entity and pays corporation tax on its profits. As confirmed in tribunal case law: "As a sole trader he paid income tax. The company pays corporation tax. PAYE is deducted from the appellant's earnings from the company but it is not his trade. It is his employment."

Income tax rates (sole trader)

A sole trader's profits are charged to income tax at the following rates under ITA 2007 s.10:

• Basic rate on income up to the basic rate limit (£37,700)
• Higher rate on income above the basic rate limit up to the higher rate limit
• Additional rate on income above the higher rate limit

For 2023-24, the main rates are: basic rate 20%, higher rate 40%, additional rate 45%.

Corporation tax rates (limited company)

From 1 April 2023, a limited company pays corporation tax at:

• Main rate of 25% (for profits above £250,000)
• Small profits rate of 19% (for profits not exceeding £50,000, with marginal relief available between £50,000 and £250,000)

For the financial year 2024, the main rate remains 25% and the small profits rate remains 19%.

Two layers of tax for a limited company

A company owner extracting profits as salary is subject to PAYE income tax, and the company itself pays corporation tax — creating a potential double layer of taxation. This is distinct from a sole trader who is taxed once on all profits.

HMRC guidance / practice

Separate legal entities and PAYE

HMRC treats a sole trader and a limited company as entirely distinct legal entities. When a business converts from one to the other, a new employer PAYE reference is required, as the change of ownership means the existing scheme cannot continue.

Tax savings from incorporation — HMRC's view

HMRC is alert to arrangements designed to exploit the difference in tax rates between the two structures. In one tribunal case, an adviser noted that "profits of the company will only be subject to Corporation Tax at a maximum rate of 25%, whereas whilst [the taxpayer] was self-employed, profits were subject to income tax and national insurance at a top rate of 52%" — but HMRC scrutinised the arrangement closely.

SEISS eligibility — sole traders only

HMRC's guidance confirms that the Self-Employment Income Support Scheme (SEISS) was available only to sole traders and self-employed individuals, not to those trading through a limited company. HMRC expressly directed that limited companies were not eligible, as "it is the company that was trading and not the individual."

Pension contributions

Net relevant earnings for pension purposes include "self-employed profits as a sole trader" and "share of profits from a partnership" — but not company profits retained within a limited company. A director/shareholder of a company would instead rely on their salary (employment income) as the basis for pension contribution limits.

Summary Table

⚠️ Important caveat: This answer covers the core tax rate and structural differences. A full comparison would also need to address National Insurance contributions, dividend taxation, capital gains tax on disposal, and VAT — for which you may wish to consult a tax adviser or refer to the relevant HMRC guidance directly.