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. There are numerous reasons for doing this - for example, the ease of setting up (there is no formal registration except with HMRC) and the ability to make company decisions unhindered by others.

However, there can be limitations in remaining a sole trader; 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) rather than 'one man bands'.

For these reasons, you may choose to change your firm's structure from being a sole trader to limited company.

What are the key differences between being a sole trader and a limited company?

  • As a sole trader, you are the business. As a limited company, the business is a separate legal entity and you are a shareholder
  • As a sole trader, all profits (after tax) belong to you. As a company director, the profits belong to the company and you are paid as an employee
  • As a sole trader, you are subject to income tax on profits. As a limited company, the business will be subject to corporation tax on profits

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
  • 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 profit-wise

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 change dramatically and without proper implementation you could face substantial penalties.

How to change from operating as a sole trader to a limited company

The process of changing to a limited company is a relatively straightforward one. 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.

Covering your liabilities as a director

If you change from being a sole trader to a limited company, make sure you let your insurer know.

You may also want to review your insurance cover. It's a common misconception that directors of limited companies are limited in their liability if the company goes bust, 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.

Find out more about directors and officers insurance.

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