Changing from a sole trader to a limited company

Changing from a sole trader to a limited company

Many professionals start their business as sole traders, and there are numerous reasons for doing this ‒ the ease of setting one up, the ability to make company decisions unhindered, the fact that there is no need to register a trade name, etc.

However, there can be limitations in remaining a sole trader. For instance, there are no rights to your company name (if a limited company is set up using your name, you can face a potential legal battle to secure it) and some clients are more confident in awarding contracts to limited companies (regardless of the size of the firm) than 'one man bands'.

For these reasons, you may wish to change your firm's structure from a sole trader to a limited company. But how exactly do you do this? Read on to find out more with Markel Direct.

What is a sole trader?

Usually, a sole trader is the only person involved in the running of a business. When you set up your business as a sole trader, you and the business are not separate entities, but one and the same thing from a legal perspective. This means that any of your own personal assets are liable should something happen to your company. This includes your home, your vehicle and your personal savings.

There are, however, some benefits of being a sole trader. All profits (after tax) belong to you and your accounting and tax can be simpler if your earnings are relatively low.

Additionally, being a sole trader may be more beneficial when the majority of your work or services can be provided from home and from you alone.

What is a limited company?

A limited company differs from a sole trader in that the former is usually owned by more than one shareholder and managed by multiple directors. As the business owner, you can choose to be both a shareholder and a director so you remain in full control of the business.

A limited company also has its own identity separate to that of its owner, making it an independent legal entity. As the business owner, your personal assets are not associated with the company at all, giving you more protection. All profits, therefore, belong to the company and you would be paid as an employee.

If you change from being a sole trader to a limited company, it is important to remember that you will have extra responsibilities. You will:

  • Be required to submit annual financial records to Companies House (instead of HMRC)
  • Need to appoint a company secretary - someone who will keep an eye on what is happening within your business and be prepared to countersign paperwork
  • Have a responsibility to set up PAYE
  • Have a legal duty to manage your company's resources and finances.

As a director, you will also need to agree on a list of terms. These may include:

  • Who has responsibility for what aspects of the business
  • What happens if one of you decides to leave
  • How the company is divided should you sell
  • What amount each director can expect to receive from profits.

If you are considering changing from being a sole trader to a limited company, it is essential you take professional advice. Legal responsibilities and tax obligations can change dramatically year-on-year and without proper implementation you could face substantial penalties.

What are the benefits of switching from a sole trader to a limited company?

It wouldn’t be worth making this switch if you weren’t going to benefit from it, so below, you can find some of the advantages of changing to a limited company.

  • You’re no longer personally liable

When you’re a sole trader, your personal assets, such as a house or car, are liable if your business goes bankrupt or owes money. As a limited company that operates under Companies Act, this isn’t the case, and so making the change could protect you and your personal possessions.

  • Personal tax will be based on salary and dividends

Making the switch to a limited company could actually mean you pay less tax. Limited companies have to pay Corporation Tax, which currently sits at 19 per cent. Sole traders, instead, are required to pay 20 to 45 per cent income tax.

If you are a director and shareholder of your firm, you can choose to take a small salary and pay yourself mostly in dividends. This can reduce the amount of National Insurance you are required to pay, as limited companies aren’t required to pay tax on dividends. It’s a perfectly legitimate way of reducing your tax.

Paying less tax enables you to reinvest more money into growing your business.

  • Claim tax relief on business expenses

A sole trader is limited to what they can expense, if they can expense anything at all. However, when you become a limited company, you can claim VAT back on all sorts of business expenses, including equipment, phones, travel, office supplies, internet, etc.

  • Build trust with your customers

People tend to put more trust in limited companies than they do sole traders. While this may not be a good enough standalone reason to make the change, it should be considered as an advantage. When you build trust with your customers, they’re more likely to make a repeat purchase and recommend you to others.

  • Protect your business name

As a sole trader, your business name isn’t protected, but when you change to a limited company, no other business can use your name. This means it’s a good idea to get your name snapped up straight away.

How to change from a sole trader to a limited company

 There are some steps that you must undertake when changing from a sole trader to a limited company.

First, you must form the limited company itself. This may sound obvious, but the business must be formed before taking any further steps. To form a limited company, you must choose a name that isn’t already trademarked or taken. Then, you should choose your directors, the shareholders and anyone else who will have substantial control within the business.

Next, you will need to prepare various forms, including a 'memorandum of association' and 'articles of association'. The government website has more information on how to complete these forms.

Finally, you should register an official address and choose the right SIC code (Standard industrial classification of economic activities) for your business.

Now that your limited company is officially formed, you can notify Companies House that your business is set up. You can usually register for Corporation Tax at the same time, so do this through Companies House.

It’s essential that you remember to tell HMRC that you’re no longer a sole trader. You should inform them of the change and request that they deregister you. Then, you will need to advise your accountant (if you have one) of the changes so they can complete your tax and accounting needs accordingly.

As you can see, the process of changing to a limited company is a relatively straightforward one, and agencies can assist in setting it up, or you can do it yourself.

There are fees for setting up a limited company, but these are not normally eye-wateringly expensive. However, the vast amounts of paperwork can be daunting and it is crucial that no steps are missed as the repercussions can be severe. Limited Company Help has a range of guides to help with the process.

Covering your liabilities as a director

When you make the change from a sole trader to a limited company, it’s really important to check that your sole trader insurance isn’t going to be affected and that you still have the right amount of cover.

It's a common misconception that directors of limited companies are limited in their liability if the company goes bust, and they will not be held personally accountable. The reality is that directors can be held responsible and legal action can be taken against them to recover funds, which puts personal wealth at risk. Directors and officers insurance covers against the costs of defending the directors and officers of a company if they are accused of wrongdoing; it is a relatively inexpensive cover (our premiums start at just £4 a month for a £25,000 limit) and can give you peace of mind that you will be covered if allegations were made against you.

Business insurance from £5 a month