8 things to consider if you are a sole trader looking to turn into a limited company 

1) Definitions
A sole trader is a person who owns and runs a business as themselves or in a partnership with another individual. A limited company is a separate legal entity – recognised as being separate from its shareholders and directors. As a sole trader, you and the business are considered to be one and the same thing. You will be held personally liable for all the debts outstanding if the business fails. Likewise, all profits earned from the business will be yours to enjoy and will be treated as personal income.

For a limited company however, profits are deemed to belong to the ‘legal entity’ and the shareholders and directors can draw down the profits either as a salary, dividend or bonus. If the business fails, the debts will also belong to the ‘company’ and the directors will not be personally liable unless they have given a personal guarantee to secure these debts.

2) How the tax system works
As a sole trader you pay income tax at 20% on the income above your personal allowance. You also pay class 2 National Insurance Contributions which is a flat fee per week and you also pay class 4 National insurance which is 9% of profits above the lower profits limit.
A limited company is liable to corporation tax – current rate being 19%. Any income withdrawn from a limited company is taxed either as earnings under Pay As You Earn (PAYE) or if a distribution of profits it is taxed as a dividend.

3) Advantages of being a sole traderIt easy to set up and you only need to let HMRC now that you are a sole trader.

  • As a sole trader all profits (after tax) belong to you which simplifies the tax arrangements.
  • There is privacy as the information about owners and the accounts are not made public.
  • You can withdraw cash from the business without tax effect. You don’t necessarily have to have a separate business bank account but it is good practice to have a dedicated account for business transactions.
  • There is no requirement to prepare statutory accounts but having a good record keeping system helps you in accurately working out your income, expenses and tax liability.

4) Disadvantages of being a sole trader

  • As a sole trader, it’s possible someone else could trade under the same name as you, and you couldn’t do anything about it. This could damage your business, and in some cases, result in you having to go through the costly and time-consuming effort of changing the name of your business.
  • Liability is unlimited and personal assets can be seized and sold to pay off business debts.
  • Business can be perceived as small, risky and likely to be affected due to changes in personal circumstances e.g. ill health or death
  • Less scope for tax planning e.g. you cannot have a company pension

5) Advantages of operating through a limited company

  • Once you register your company with Companies House, your company name is protected by law and no-one else can use the same name as you or anything deemed to be too similar.
  • Because the company is a separate legal entity from its directors the company can own equipment incur debts and pay bill sin its own right. That means that if the company is sued you will not be held personally liable for the debts of the company and your personal assets cannot be seized to pay for the debts unless you have given a personal guarantee to the creditor.
  • A limited company is seen as a more stable entity and some businesses are more confident in awarding contracts to limited companies (regardless of the size of the firm) rather than sole traders.
  • It is easier for a limited company to attract investment by selling shares to an investor whereas for a sole trader you would need to restructure as a partnership in order to attract investment.
  • It is easier to transfer ownership of the company by transferring shares.
  • You could save on tax by operating through a limited company

6) Disadvantages of a limited company

  • Requires formal registration with Companies House and information about the directors and shareholders is available publicly.
  • Requires more paperwork each year as a limited company is required to file a set of accounts, an annual confirmation statement and a corporation tax return. If running a payroll, there is also a requirement to file a Real Time Information report to HMRC every time a director is paid.
  • All profits (after tax) belong to the company and you are paid as an employee
  • Expenses are treated differently to a sole trader and directors may be taxed on certain benefits received from the company e.g. use of company car.

7) Steps to change from a sole trader to a limited company

  • Obtain an accurate valuation of your business assets as at the day you want to change to a limited company. These assets will be ‘sold’ to the limited company and you can draw down the value from the company.
  • Inform all of your existing customers, suppliers, lenders, service providers and employees that you are going to start trading as a limited company.
  • Register the company with companies House and set up a business bank account in the company’s name. Your accounting requirements will be more complex when you begin trading as a limited company.
  • Register with HMRC for corporation tax, and Value Added Tax (VAT) – if necessary.
  • To be able to pay yourself a director’s salary, you must first register your company as an employer. If you already employ people, you should speak to HMRC about the change of business structure
  • Let HMRC know that you have stopped working as a sole trader and consequently don’t need to pay Class 2 national insurance contributions. You will complete your self-assessment tax return as usual. After this you will need to submit tax returns the following year as a director and shareholder.

8) Steps to change from a limited company to a sole trader

  • Apply to Companies House to strike off the company from the register.
  • Companies House will place a notice in the gazette giving two months’ notice before strike off.
  • If there are no objections to the application the company will be struck off the register.
  • Remember to inform HMRC if you start trading again as a sole trader.

What next?

If you have any questions about running a business either as a sole trader or a limited company, or you would like help with changing from a sole trader to a limited company, or indeed from a limited company to a sole-trader, please complete the form below and we will contact you for further discussion.

About the Author:

Lenah Oduor is an accountant and business advisor with a passion for helping businesses be more efficient and be more profitable through use of technology and streamlining of processes. She has written a book ‘7 key numbers you really ought to know (because most business people don’t)’ which looks at the key numbers you need to measure and track in order to grow your business.You can get a free copy of the book on our website. Lenah is the owner and principal accountant at gHawk Accounting.

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