Changing from Sole Trader to Limited Company

When it comes to deciding upon the structure of your company, there really is no easy answer. Everyone’s situation is different, and what’s right for one person might not be right for another.

There are lots of things which might influence your decision:

  • The type of business you run, or are thinking of running
  • Your future plans to grow the business, or not
  • What level of commercial risk you will be exposed to
  • What kind of administrative support you have, if any
  • How you wish to be perceived by customers

The most important factor of all is your own personal preference, you may just prefer to operate through a limited company rather than as a sole trader. But in order to make that decision, you must have all the information to hand.

Which business structure is right for me?

The four main options to consider are:

  • Sole Trader: an individual
  • Partnership: two or more individuals or companies
  • Limited Liability Partnership (LLP)
  • Limited Company

What is a limited company?

Basically, from a legal point of view, a limited company is totally separate from the person or persons who form it. That means, in real terms, that you and your fellow directors or shareholders have ‘limited liability’. Hence ‘limited company’.

If you choose to be a sole trader or other non-limited business, your personal assets (house, car, etc.) are potentially at risk if your company fails. But for a limited company, there is an element of protection. As long as your business is operated legally and within the terms of the Companies Act, then your personal assets are not at risk.

On paper, therefore, the option to ‘go limited’ seems obvious. Still, before you make that decision, you need to weigh up the pros and cons. Here are some questions which our customers have asked us over the years, along with some answers which we hope you will find useful.

How much administration is involved?

Your administrative responsibilities involve sending your annual accounts to Companies House by a fixed date each year, completing an Annual Return (a list of directors and shareholders) and submitting a tax return and accounts for Corporation Tax purposes. You will also have to complete a personal tax return.

The administration isn’t difficult or particularly time-consuming but it is easy to miss tax-saving opportunities, for example, would your business be better on the standard VAT scheme or the Flat Rate VAT Scheme, and what’s the most tax-efficient way to take money out of your company? This is where it’s useful to have a good accountant. They will also make sure you never miss a tax deadline and incur penalties.

What rate of tax do I pay as a sole trader vs limited company?

A ‘small’ company will pay the company (corporation) tax at 20% on its profits. How you will be taxed personally is dependent on the level of income that you draw from the company. This income can be structured in a tax-efficient manner.

You also have the option to leave ‘reserves’ in the company to help with future growth and development (remember, with a limited company you only pay personal tax on the money you take out of the business). As a sole trader or partnership, you will be taxed on the profits of the business as they fall, not on what you have drawn from the business which is not as flexible in terms of future tax planning.

Will I earn more money as a limited company or sole trader?

If profits are above £25k per year you may benefit from going limited; however, even if your profits are lower it’s probably still worth having a chat with an accountant as they are able to find ways to make your company more tax efficient.

Is a sole trader mortgage easier to get than a limited company mortgage or loan?

Some banks look more favourably on directors of limited companies, but it really does depend on the bank. Since the advent of self-certification, it shouldn’t really matter.

Take-home pay comparison: Sole Trader vs Limited Company

One of benefits of changing from sole trader to a private limited company is the tax planning opportunities that it offers. Effective tax planning can ensure tax efficiency which, in turn, can increase take-home pay.

Limited company directors may structure their pay and dividends throughout the tax year to legitimately minimise the tax due on personal income.

Sole traders, in contrast, can’t. This is because they don’t work via an intermediary (the limited company) and all income is received personally by the sole trader, as opposed to being received by the business.

What are the costs of setting up and maintaining a limited company?

Of course, equally important to consider when changing from sole trader to limited company is the difference in running costs that you’ll incur.

Setting up a limited company isn’t expensive and if you’re happy and comfortable dealing with the administrative tasks involved, you can save some money there.

However, it can be faster and easier to appoint an accountant who can form this on your behalf. An accountant can also help you to stay on top of all regulatory deadlines and ensure that your tax bill is paid on time.

At Caroola, we offer competitive limited company packages so that you can focus on doing what you do best while we take care of your tax obligations.

How do I decide how much to pay myself and how much to leave in the business?

This is entirely up to you, as long as the business can afford it. You need enough to live on, but there is no point in taking out more than you need and being taxed personally on it.

Profits are usually taken as dividends which do not attract National Insurance, which may help reduce your overall tax liability.

Are there other benefits I can gain from forming a limited company?

There are a number of benefits to be gained from setting up a limited company, the most important of which is the ‘limited liability’ outlined above. However, there are a number of other benefits, such as:

Operating as a limited company may offer more credibility and give suppliers and customers more confidence in your business. In fact, it’s often the case that larger companies will even choose not to deal with non-limited companies.

The cost of managing and operating a limited company is not that much more than with non-limited businesses. From a taxation and accountancy point of view, the changes in legislation over the last few years have meant much lower costs associated with limited companies.

You don’t have to start trading within any set time period after you become a limited company. This means that it's actually a simple and cost-effective way to protect your business name, as no two limited companies can exist with exactly the same name. Many people form companies in anticipation of the future creation of new businesses, or to protect the name of an existing non-limited business for the future.

It is also very simple and straightforward to have more shareholders if you decide to grow and offer shares in your business

If you decide to sell, it may also be easier to find a buyer for a limited company rather than a sole trader.

How do I switch from sole trader to limited company?

In order to make the switch from working as a self-employed individual to operating through your own limited company, the following steps must be completed:

  • Form your limited company
  • Transfer your sole trader business to the limited company
  • Setup a business bank account in your company name
  • Get in touch with HMRC, to inform them of the change to your company structure
  • Again, contact HMRC to de-register as self-employed. You will then stop paying self-employed class 2 National Insurance contributions
  • Notify business stakeholders about the change of the business’s structure
  • Advise your accountant of the changes, so that they can adjust any tax calculations
  • Register for corporation tax and PAYE (either you or your accountant can do this)

Although there are many steps to setting up your own limited company, the first step is one of the most important. Choosing a company name requires a lot of thought, as you may have built up a reputation under a name you used whilst self-employed. You may opt to choose a name which is particularly relevant to your industry. If you have an idea of your company name, Companies House offers a useful tool to check if it is available.

Once you have chosen a suitable company name, you can then form your limited company online. Our company formation page contains all the information you need to know. We understand that setting up your limited company is important; our limited company formation service can have your company up and running in no time.

What happens if I change my mind and decide I don’t want to be a limited company after all?

All you have to do is complete a form to be removed from the register of companies at Companies House.

Find out more

To learn more about the differences between these two structures, take a look at our guide to sole trader vs limited company.

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