Switching from Sole Trader to Limited Company

So you’ve been running a business as a sole trader, but is it time to make a switch to a different organisation type? Many companies may start as sole traderships, and why not? It’s a cheaper and more straightforward way to set up a business, especially if you’re a first-time business owner. However, as time goes on you may find that working as a sole trader can be quite restrictive.

Switching to an LTD from a sole trader can come with a few benefits, such as; limited liability, potential tax advantages, easier access to funding and increased credibility. We’ll discuss these benefits below as well as highlight all the necessary steps you need to take to switch from a sole trader to a limited company set-up. 

Why Change from Sole Trader to Limited Company?

Transitioning from a sole trader to a limited company is a big decision and one which needs careful consideration. While a business can operate as a sole tradership for its lifetime, switching to an LTD formation is often better for longevity and growth. Plus, there are a number of other benefits too!

Limited Liability Protection

The biggest benefit is liability. As a sole trader, you are fully responsible (liable) for your company. However, as a limited company, you’ll have limited liability.

As a sole trader, your company and you are one legal entity. A benefit of this is that your profits after tax belong to you. However, this also means that your company's liabilities belong to you. These liabilities include assets and intangible things such as debt. Unfortunately, with unlimited liability, if your company were to go bankrupt, you’d have to pay out of pocket to cover its debts.

On the other hand, a limited company has limited liability. This means that you are only responsible for the money/assets you put into the business and your company is a separate legal entity to its owners and managers. If your company goes under you’re personal liability is protected up till your initial investment.

Limited liability is a huge benefit for business owners. It allows you to run a company without risking your personal assets and finances.

Tax Benefits

A limited company is taxed differently from a sole trader, and if your company is making a lot of revenue, you may find that a limited company’s tax structure suits you better.

With a sole tradership, you’ll pay two kinds of taxes on your revenue; income tax and National Insurance Contributions (NICs). Because there’s no legal separation between sole traders’ personal finances and those of the business, you’ll pay Income Tax on your profits whether or not you use them personally. You’ll only pay income tax if you earn over the threshold of £12,750 per annum.

These taxes are calculated during your yearly self-assessment, which is submitted by Jan 31st every year. This means as a sole trader you’ll need to prepare for a yearly tax bill, which can be hard to plan or budget for. Secondly, you may find that you’re paying higher tax rates on your NICs compared to limited companies.

As a limited company, you’ll pay Corporation Tax, also known as company tax. Corporate Tax rates are typically lower than Income Tax rates. Secondly, directors may choose to forgo a salary, or pay themselves a below-threshold salary, and supplement the rest of their salary through dividends. This allows you to be more tax efficient as dividends have a lower rate than NICs and Income Tax.

However, it's important to note that a limited company’s tax structure is only beneficial if you are earning enough! This is because you’ll start paying Corporation Tax from the first pound of profit you earn, which means unlike a sole trader you won’t have the tax threshold as a buffer.

Overall, A limited company tax structure can be more efficient and can help you save on taxes. 

Professional Image

Finally, a benefit of the LTD structure is the added professionalism it lends your company.

As a sole trader, you may find it hard to land larger clients or funding due to their perceptions of sole traderships. Often, a limited company is perceived as stable and reliable, whereas a sole tradership can be harder to bet on. Secondly, some funders or investors may insist on an LTD structure when you apply for funding for the same reasons of stability and reliability.

Many companies prefer working with LTDs over a sole trader, so being an LTD could increase your work and funding opportunities. 

Initial Considerations

Of course, an LTD structure is not beneficial for every business. There are a few things you need to consider becoming a limited company. Such as your company’s readiness, as well as your financial and business planning.

It’s incredibly important to assess whether your business is ready to change from a sole trader to a limited company. The key thing to assess is whether your business is financially stable enough to transition. You’ll need to go over your annual turnover, profit margins, and growth potential. In particular, you’ll need to consider whether the new taxation structure will be suited to your company’s current future revenue.

It’s advisable to consult an accountant or finance professional before switching from a sole trader to an LTD. A professional can help advise on the intricacies of tax or finance and even highlight any legal requirements or changes you may need to make. Finally, a professional can help you and your company stay compliant with company law. 

Registering the Limited Company

Once you’ve assessed your business the next step will be to form your limited company. Forming a limited company is a straightforward process, but it requires careful attention to detail. 

There are a few ways to form a company in the UK, you can apply directly with Companies House using their online application portal or via post, you can use a lawyer or accountant to form a company or you can use a company formation agent– like us. 
We’re outlining the DIY route below, however, if it's your first time forming a company or if you have any doubts or questions about the process we recommend working with a company formation agent. 

Most company applications are delayed or rejected due to easy mistakes or misunderstandings. When you form with us we double-check your application and, if you need it, we even guide you through the process.

Choosing a Company Name

Your first task is selecting a unique company name that complies with UK company regulations. You cannot use names that are already registered or contain sensitive words, such as ‘Great Britain’ or ‘King’. Use our free company name checker tool to confirm your choice of name is available for use. Don’t forget: a memorable and relevant name can strengthen your business identity, so choose wisely! 

Registering with Companies House

To become a legitimate limited company you must be registered with Companies House, the UK’s registrar of companies. The most direct way is via the online registration portal, which costs £50. 

You'll need to prepare key documents, including a Memorandum of Association (outlining the intent to form a company) and Articles of Association (detailing the rules for running the company). These templates are available online, or you can customise them to suit your needs or hire a lawyer to draft them. When you form with us, you can use our templates which are suited for most new small businesses. 

During the formation process, you need to provide details regarding the company’s registered office address, directors, and shareholders. 

You must get these details right the first time. Incorrect details about your company officers can cause your company application to be rejected. Secondly, in order to fix these details you’ll need to post a form to Companies House– so double, triple check before you send off your application. Finally, don’t forget that your registered office address will be publicly accessible on the Companies House register. For this reason, many business owners choose to opt for a registered office address service which allows them to have a compliant registered office which also conceals their home address. 

• What is a registered office address? 

Appointing Directors and Allocating Shares

Every limited company must have a minimum of one director who is legally responsible for managing the business. A company director’s personal details, including a residential and service address and dates of birth, must be submitted to Companies House. 
Any shareholders must also be appointed at this point, and your company’s shares should be allocated appropriately. We recommended allotting one share per shareholder and keeping the price of a share to £1. Keep in mind that shareholder agreements, while not legally required, can help avoid disputes later.
After submitting the application, Companies House will confirm your registration by issuing a Certificate of Incorporation. This document formalises the creation of your limited company, allowing you to start trading under its name.

Transferring Assets and Liabilities

Of course, if you have an established sole tradership you’ll need to undertake a few legal requirements to shift your assets and liabilities from your sole trader business to your shiny new LTD. 

Transferring Business Assets

When transitioning from a sole trader to a limited company, the first step is identifying and valuing your assets. Then transferring assets from a sole trader to a limited company. These may include equipment, vehicles, stock, intellectual property, and goodwill. Each asset should be assessed at its fair market value to establish a realistic transfer price. Accurate valuation is essential as it impacts both the company’s financial statements and your tax liabilities.

Formal agreements, such as a sale of assets agreement, are required to transfer ownership from the sole trader to the limited company. It’s incredibly important to document the process in order to avoid potential legal disputes and ensure compliance with HMRC regulations.

Finally, as your LTD is new you may not have the funds to buy the assets. In this case, it's common for the company to create a director’s loan account. With this, the company pays its director over time to cover the transferred assets. 

Transferring assets can be tricky and it may also trigger a few tax liabilities, such as Capital Gains Tax. If in doubt, speak to an accountant or an expert for help and advice.

Transferring Liabilities

Transferring liabilities, such as business loans, leases, or supplier contracts, is another essential step. 

First, you’ll need to identify all existing obligations and notify any creditors or counterparties about the change in business structure.

In some cases, lenders or lessors may require you to renegotiate terms or provide personal guarantees as the company’s director. There may also be tax implications, such as potential capital gains tax on assets sold to the limited company. Additionally, the transfer may impact VAT registration, as the new entity will need to register separately if applicable. 

As always, if you’re in doubt reach out to an accountant or legal professional who can help navigate these complexities. Don’t forget: proper planning will help mitigate risks and establish a solid foundation for your limited company.

Informing HMRC and Other Authorities

Informing HMRC

Notifying HMRC is a key part of transferring from a sole trader to a limited company. Luckily, it is quite straightforward to do so! 
Start by completing your final Self Assessment Tax Return, and make sure you declare the date you ceased sole trader operations- this officially notifies HMRC that you are no longer a sole trader. 

If you need to, pay any outstanding tax or National Insurance liabilities. Once this is done, register your new limited company for Corporation Tax, if you haven’t already done so. This can be done during the incorporation process or directly via the HMRC website. You’ll need your company registration number, start date for trading, and registered office address on hand.

If your sole trader business was VAT registered, you’ll need to inform HMRC about the change in business structure. Depending on the circumstances, you may need to transfer your VAT registration to the limited company or cancel the old registration and reapply under the limited company name. It is crucial to keep all of your business records with HMRC up-to-date in order to remain compliant and avoid penalties.

Informing Other Authorities and Stakeholders

Beyond HMRC, you’ll need to update any relevant business licenses and permits with the new company details. Simply, contact the issuing authorities to transfer or reissue them under your limited company’s name. This is particularly important for businesses in regulated industries.

You should also inform clients, suppliers, and other stakeholders about the change in your business structure. Provide them with your new company details, including the registered name, company number, and updated contact information. This will help keep continuity in your professional relationships and avoids any confusion regarding invoicing or contracts. Clear communication about your transition can also strengthen trust and transparency with your business partners.

Updating Business Information

When switching from a sole trader to a limited company, one of the first tasks is updating your financial accounts. It is essential to open a new business bank account in your company’s name. As your limited company is a separate legal entity to you, all company income and expenses need to be processed separately from personal finances. 

Secondly, make sure to transfer any funds from your sole trader account to the new business account and close the old account to avoid confusion. Separate financial records are not only a legal requirement but also simplifies your tax reporting and accounting processes. So do your best to keep on top of it! 

You must also update any business insurance policies to align with the new company structure. You can do this by notifying your insurance providers about the change! Particularly if you have policies such as public liability, professional indemnity, and employers’ liability insurance. These insurance types may require adjustments or entirely new contracts. 

Finally, you may need to review existing contracts with clients and suppliers. In particular, be sure to update or renegotiate these agreements under the new company name to make sure they are still legally binding.

Tax and Accounting Implications

Understanding the tax and accounting implications of transitioning from a sole trader to a limited company is vital for keeping compliant. 

Corporation Tax

Once your limited company is established, it must be registered for Corporation Tax with HMRC. 

This can be done during the incorporation process or directly through HMRC. Corporation Tax is charged on company profits at a fixed rate, currently 19% for most businesses in the 2024/25 tax year. 

As a director, you’ll also be required to file annual Corporation Tax returns, providing a detailed account of your company’s earnings and expenditures. Failure to comply with these requirements can result in penalties, so make sure you apply and file in time. 

VAT Registration

If your sole trader business was VAT registered, you’ll need to transfer this registration to the limited company. This can be done via your online account. 
For businesses importing or exporting goods, it’s especially important to update HMRC on changes to VAT arrangements to avoid disruptions.

Handling Payroll and Dividends

If your limited company has employees, including yourself as the director, you’ll need to set up a payroll system to handle salaries. This includes deducting PAYE and National Insurance contributions and submitting these to HMRC. 

For directors and shareholders, dividends are a common way to withdraw company profits. Dividends are taxed differently from salaries, offering potential tax savings, but require careful planning in order to be tax efficient and compliant. If in doubt, talk to a tax professional. They can help you strike the right balance between salary and dividends to make the most of your personal and business tax obligations.

Legal and Compliance Requirements

When switching to a limited company, it’s crucial to understand the legal and compliance obligations that come with your new business structure. Ultimately, if your company is not compliant you can face some serious penalties and even be struck off the register. So make sure you understand the regulations surrounding LTDs and stick to them. 

Directors’ Responsibilities

As a company director, you have significant legal responsibilities under the Companies Act 2006. 

You must act in the best interests of the company and its shareholders. This includes maintaining accurate and up-to-date financial records- these records underpin your company’s annual filings and tax reporting. 

Additionally, all directors must keep their company compliant with all statutory requirements, such as filing returns on time. Regular board meetings should also be held to document any key decisions and uphold corporate governance standards.

Annual Filings

Two key compliance tasks are filing an annual Confirmation Statement and Annual Accounts. The Confirmation Statement, submitted to Companies House yearly, confirms the accuracy of the company’s details, including directors, shareholders, and registered office. Failing to file this document can result in penalties or even the company being struck off the register.

Similarly, Annual Accounts must be prepared and filed with Companies House. These accounts provide a snapshot of the company’s financial health, including profit and loss, balance sheets, and cash flow statements.

Larger companies may require an audit, while smaller companies can often submit simplified accounts. Both filings are critical for maintaining compliance and demonstrating the company’s operational integrity.

By fulfilling these requirements you can avoid penalties and keep your company up and running. 

Conclusion 

So there you have it! Everything you need to consider before switching from a sole trader to an LTD business structure. With careful planning and consideration, you can make the transition between company structures smooth and effortless.

Becoming an LTD comes with many benefits, from limited liability, tax efficiency and an enhanced professional image. However, it’s crucial to take your time and assess if your business is ready.

Are you ready to make the switch? We’re here to help. We’ve been helping business owners, like you, form their companies since 2002. We can help make the transition from a sole trader to a limited company even more easier. We have packages suited for every entrepreneur, from basic to ultimate, we can help set your company up for success. What are you waiting for? Set up a company today and begin your dream business!