When to consider switching from a sole trader to a limited company

Every business chooses a legal structure that suits them when they begin their journey, but how do you know if it’s the right time to change the structure due to growth or new opportunities? This article will look at when you should consider switching from one structure to another by diving into the following areas: 

• What’s the difference between a sole trader and a limited company?
• When to consider switching from sole trader to limited company?
• How to change from a sole trader to a limited company?

Let’s start by looking at the two types of company structure.

A sole trader is a self-employed business owner who is often the only owner (or sometimes a partnership in a partnership) of a business. The owner has complete control of all aspects of the company, including all profit earned after taxes, which is likely why it’s the most common type of business structure.

It’s probably easier to manage business finances as a sole trader as there is less tax and financing reporting to do. Still, they will be personally responsible for any debt, unlike a limited company owner who will possess limited liability for any business debts. 

A limited company is a structure where the business is its own legal entity, separate from the owners (the shareholders) and the people who manage it (directors). The company can still be owned and operated by one person, where the owner acts as both shareholder and director. The businesses finances are then entirely independent of the owner’s personal credit file.

Limited company owners may act as the shareholder and director but will pay themselves as an employee via PAYE. This means that you will no longer be a ‘self-employed’ person in the eyes of HMRC and won’t submit your personal income tax through a self-assessment.

The choice you make about your business structure can impact every aspect of your business, from your bottom line to the paperwork and tax reporting you have to manage. Therefore, there are many things you should consider before making the change. 

It’s essential to weigh up the options properly because you may end up spending too much time on administrative tasks when you could be growing the level of profit you’re making instead. You may want to enlist the help of an accountant or financial advisor with this decision. They have the experience to help you make an informed choice, and retaining their services will save you time since a limited company has much more record filing responsibilities, and they can support many aspects of your business after transitioning from sole trader.

Some questions to ask yourself to decide if it is time to make the change are:

• Will you pay less tax by operating as a limited company? Once you’re hitting a certain profit level, it may be more tax-effective to incorporate your business (become a limited company).
• Will you receive a higher take-home pay by using a limited company? When your business is making more profit, then you may be making more turnover. Still, you have to consider if you’ll be taking home more, with the added costs associated with running a limited company.
• Will a limited company’s more ‘professional’ image help your business attract more customers/clients and grow the business?
• Will you benefit from limited liability, and will your personal assets need to be protected if the business goes bankrupt?
• Do you want to bring in investors, secure funding, or find business partners in the future?
• Are the other benefits listed worth the extra filing, record keeping and administrative requirements that limited companies are legally required to manage?

Be honest with yourself about the answers to these questions, as choosing to switch from sole trader to limited company can alter the running of your business altogether.

If you decide to make the change, then follow these steps to register your limited company:

• Register your business with Companies House. This registration is called incorporation and will cost you £12. You can operate under the name you were using as a sole trader or choose something new. Always check that your business name is available, or you could face legal issues.
• First, get in touch with HMRC to inform them of the change to your company structure.
• Next, with HMRC, set up your salary payments through PAYE as you’ll be paying yourself as an employee. 
• You’ll also need to register for Corporation Tax, and if your business is likely to turn over more than £85,000, you’ll also need to register for VAT.
• Finally, use an online form to inform HMRC that you are deregistering as self-employed.
• Limited companies legally must have separate accounts from the owner’s personal one, so set up a business current account if you don’t already have one.
• Transfer the sole trader company and any assets it has to the new business. You could seek support from an accountant or financial advisor for this process, as it can be complicated. Simply put, your new company must buy assets (e.g., cash, equipment or vehicles) from the old company. The value of the assets can be paid immediately or treated as a loan to be repaid over time.

If you change your mind and decide you prefer to operate as a sole trader again, you can notify HMRC of the change and re-register as self-employed. 

By setting up a Countingup business current account, you can manage all your financial data in one place. The app comes with free built-in accounting software that automates the time-consuming aspects of bookkeeping and taxes. 

You can view real-time insights into your business’ finances, such as cash flow and profit and loss statements. The app provides running tax estimates so that you always know how much to set aside for your tax return. 

Save yourself hours of accounting admin and find out more here.