How to Change from a Sole Trader to a Limited Company

28th May 2019

It’s common for many business owners, to begin trading as a sole trader rather than a limited company. Sometimes, working as a sole trader suits the business model of your new start-up. So, being a limited company never really crossed your mind.

Generally, for businesspeople who are looking to make this transition, it’s because they are ready to expand. Regardless, of the “whys,” you’ve probably found this article because moving from a sole trader to a limited company is a viable option.

The main complexity concerning this transition is the legal side – but don’t worry we’ll explain this in more detail. This article aims to help business people who are thinking about or are ready to move from a sole trader to a limited company.

Since there’s a lot of business and legal jargon, we’ve tried to simplify this process as much as possible. We’re also going to look at some of the pros and cons of this business transition. Besides the important aspects and process involved in this process.

Although changing from a sole trader to a limited company seems complicated at first glance. If you have the right support, business model and guidance, it’s quite simple. Let’s start by looking at the differences.

What is the difference between a sole trader and a limited company?

According to official definitions on the GOV.UK website:

Sole trader

Women sat at desk typing on a computer

comprises of one individual, (possibly you in this case), who is the sole owner and operator of the business. The reason many new start-ups and entrepreneurs prefer this route is that is a straightforward process to set up. As a sole trader, you still need to register on with HMRC, as well as completing your annual taxes.

Limited company

gives a business its own legal identity. All people who are involved in the day to day running, from directors to employees, as well as shareholders are not legally tied to the business. So, let’s say you make the transition and you are the only “employee,” your company will still be separate.

Following on from the above definitions, one big misconception when it comes to the two business models is that you can’t have a limited company with one person. Arguably, this assumption comes from the fact most sole businesspeople, tend to operate as a sole trader.

Which option is better: a sole trader or a limited company?

We’re going to presume that you’re currently operating as a sole trader. Like all things, there’s pros and cons to both options. Now, we will look at the main pros and cons of being a sole trader or a limited company, before we help you decide if changing to a limited company is an opportune move.

Sole Trader Advantages

Laptop placed on desk next to a pot of stationary

First, we’re going to look at the pros of being a sole trader:

  • Easy to set up, manage, requires little HMRC paperwork, which is the self-assessment tax return (SA302)
  • As a sole trader, you do not have to register with Companies House, which means you have more privacy.

Sole Trader Disadvantages

You may already be aware of these disadvantages (and advantages) if you’re already operating. But, we thought a quick refresher always helps. It’s also good to have a visual comparison of the pros and cons of a limited company.

  • Liability, as you and your business are essentially viewed as one entity under UK law, it means you will be liable for any debt. For instance, if the business was to experience a deficit and accumulates debt, the appointed sole trader will have full responsibility to repay the company’s debt.
  • Limited expansion or investment prospects. Now, this con isn’t always the case, but most banks or investors prefer to invest in limited companies, rather than sole traders.
  • Unkind tax rates, depending on where your finances/income is the tax rates can be quite costly. Sometimes, it’s more feasible and cost-effective to change to a limited company once you meet the highest tax criteria.

Limited Company Advantages

Boardroom full of men and women siting in front of laptops

Next, we’re going to look at the benefits of changing to a limited company.

  • Non-liable, unlike a sole trader, a limited company is a separate legal entity. Basically, even if you’re the sole operator/employee you would only lose the initial investments and assets. Moreover, your personal assets are not tied to the company, unless something like a car was purchased through the business
  • Tax efficiency, now this advantage is quite broad, as it depends on the profit margin. That being said, the taxes are arguably more accommodating. The main difference is that rather than being taxed on income, limited company taxes are calculated based on profit.
  • Your company name is protected, all limited companies must register with Companies House. So, once your business name is registered, you are fully protected against anyone using it, unlike a sole trader.

And, the disadvantages…

  • More responsibilities. As a limited company, there’s a lot more involved, and these responsibilities fall under the Directors Fiduciary Responsibilities. In a nutshell, these a mandatory requirement that you must do as the legal director of the company. These responsibilities also include filing a yearly annual tax return, besides the annual accounts.
  • Time-consuming, due to the additional paperwork and responsibilities, which is why a lot of limited companies use an accountant.
  • Your business information becomes public, unlike a sole trader, Companies House shares all the information on the listed directors, as well as your companies’ earnings.

Now, we have briefly outlined the advantages and disadvantages, we’re going to move on to the next section. However, we’d like to point out that we always recommend that you weigh up the benefits and disadvantages before jumping into a decision.

Even, if you know that your company is ready for this expansion, it isn’t a decision that should be rushed. Hopefully, we can help you decide if changing from a sole trader to a limited company is the right move for you and your business.

Is now the right time for your business to change to a limited company?

In short, it all depends. Now, you’re probably thinking “hold on this is meant to help my decision.” So, we’d like to clarify on our somewhat blunt answer. When we say depends, it includes factors like:

  • Profit
  • Industry
  • Nature of business (for instance freelancers or e-commerce stores)
  • Time
  • Future Plans

We’d like to elaborate a little more on “future plans.” Often in business, we here, what are you “five-year plans?” In a way, this seemingly annoying interview-style questions works in this context. If you want to expand and grow your venture, are looking for investors and employees, then these should be part of your business plan.

As a limited company, you don’t really have the flexibility to “wing-it” or “play it by ear,” – not if you want to succeed. We’re confident when we say that most entrepreneurs, the dream of a profitable venture. Now, as a sole trader, you can be limited, as mentioned above with investors and even tax.

Generally, most business owners begin to consider this transition when it becomes too costly regarding taxes. There seems to be an unwritten rule that once you own over £30,000 it’s time to consider becoming a limited company.

people sat round a table, with notepads and a laptop on the table

Now, yes, in terms of taxes it can be beneficial, but it shouldn’t be your sole motivator. As we’ve said, it’s an unwritten rule. In fact, there is not an actual ballpark figure or a rule that says once you earn over the £X amount you must become a limited company.

In our experience, we’ve helped sole traders become a limited company when their profits were lower than £30,000. Besides, we’ve helped individuals who didn’t make the transition, even though they made over £50,000. So, when is it the right time? Well, as we said it depends – on you, your business model, needs and future plans.

However, if you’re unsure about any of the above considerations, it’s best to seek advice. There’s plenty of friendly businesspeople, who respond to queries, for instance in LinkedIn groups. You can also look for professional advice from a financial advisor or accountant, to gain a clear picture if this will be a viable and worthwhile transition.

How to Change from a Sole Trader to a Limited Company

We’re now in the second part of this article. In this section, we will be looking at the processes involved in more details. In our opinion, the hardest part of moving from a sole trader to a limited company is making the decision that now is the right time.

However, the process itself is quite straightforward. You have three options really to make the change:

1. Set it up yourself

2. Use an accountant

3. Go through an agency

Mind map with a hand pointing at one of the squares

Hopefully, we don’t sound too biased, but option one or two are the best options. Although there are some really great agencies out there, the price (fees) are less than great. We’d like to add that there is no right or wrong answer concerning, which set up the option you should use. Again, it comes down to what is best for you.

However, when it comes to this process, you must ensure everything is accurate. If you want to avoid nasty repercussions. Especially if you’re doing it yourself, we recommend asking someone to look over everything, before submitting it to HMRC.

The five key steps to move from a sole trader to a limited company

Besides, the considerations above there are obviously some formalities and legal requirements. Sadly, it’s not as easy as just making the decision to change from a sole trader to a limited company. So, to make it easier, we’ve broken down the five key steps.

Step One: Decide on directors

As noted, a limited company allows you to hire employees. It also means that you can have more than one director. So, the first decision you need to make is if you’re going to be the sole director, or you’re going to bring some people to the company.

Step Two: Notify HMRC

A pad with tax written on it with a hand holding a pen above it.

This step is crucial, you need to notify HMRC that the legal standing of your company has changed. Our recommendation is to do this once you have decided on how many directors.

The faster you notify HMRC, the better. Not only that, when you tell HMRC that you’re companies legal standing has transferred to limited, your tax rates will be amended.

Step Three: Name your Business

Now, you may already have a business name. However, for those of you who have been operating with your actual name, you might want to reconsider or adjust the name slightly.

Although presumably many of you will have been operating for a while, so you might not want to change it too much. 

If you’re stuck for inspiration. We’ve written a blog on “How to choose the Best Name for your Start-up.”

Step Four: Register your Business on Companies House

Someone typing on a laptop, filling in a sign up form

This step is where the excitement kicks in, it will feel like the first day that you opened your business venture. You can either register on their site directly or ask your accountant to help you with this process. The only difficult part of this step is possibly creating your memorandum and articles of association.

Step Five: Set up a Business Bank Account

Unlike a sole trader, you cannot use your personal account for your business banking needs. Once you’ve registered as a limited company, you and your business are legally separate.

There are many great business accounts available. However, before jumping at what seems like a great deal. For instance, free banking for six months, make sure that you check the costs after the trial period.

Quick Summary

Since there’s a lot to take in and process, don’t be put off, if it’s financially viable and beneficial for your business. The five steps above are the crucial aspects that are involved when changing from a sole trader to a limited company.

Man Standing in front of a board covered in papers

As we said earlier, the hardest part is assessing whether it’s the right move for you and your business. However, if changing how you operate legally, is a viable move, then we recommend doing it. Especially if you have plans to expand, grow and even seek investment.

Should I continue operating as a sole trader?

Again, without sounding too vague, it all depends. For instance, if you’re still in your second or third year, and your profit margin is relatively low. It might be best to wait, assess your competition, and see if there is room for your business to thrive as a limited company.

Moreover, if you prefer the simplicity of the paperwork, tax filing, bookkeeping and you’re happy to pay a higher tax bracket. Then yes, stay as a sole trader. You are perfectly within your right to do so.

However, we would like to say if you’re only off-put by the paperwork. You should assess the needs of your business and whether it’s more cost-effective to operate a limited company.

Are there any other benefits if I change from a sole trader to a limited company?

Now, please note that this article is to purely educate businesspeople, like yourself, who are considering this change. The tips and guidance are only there to help. At Pearl, we are not only dedicated to our existing clients but all budding entrepreneurs.

Likewise, we understand that we’ve covered the pros and cons, between the two-trading option. Besides the earlier advantages, there are quite a few benefits, which may outweigh the additional paperwork and time.

So, let’s look at some of the additional benefits:

1. Your Personal Tax might change for the better

Coins and pens stacked on top of papers

We’re sure that you’re aware that as a sole trader you pay tax on your profit. Now, if you begin making over, £30,000 (as we said the “unwritten” rule), it can be more cost-effective regarding taxes. As a limited company, you will still pay tax personally, but it will be based on your salary and any dividends that you take (if any).

2. You can apply for tax relief 

If you have a limited company, then you will pay corporation tax on the profits. Corporation tax is calculated, prior to you taking dividends. Unlike a sole trader, you can claim all business expenses if they impact your profit.

The Bottom Line

We’ve now shown you the simple and complex process involved when making the change from a sole trader to a limited company. Making the decision itself comes purely down to the viability of your business.

Generally, our advice regarding this transition is to make sure you do thorough calculations, including reviewing your books, accounts and annual sales. This process may seem tedious, but it will give you a clearer understanding of whether it’s worthwhile.

Light bulb surrounded by idea bubbles

Many businesspeople often make the change from a sole trader to a limited company and thrive. But the bottom line is always making the right decision for your business. If it’s financially beneficial and will provide you with opportunities to grow your business, then a limited company can help you achieve these goals.

If you have any questions regarding how to change from a sole trader to a limited company, Pearl is here to help you. We have assisted many businesspeople to make this transition seamlessly.

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