How to switch from a sole trader to a limited company

As a self-employed professional, you have to decide whether to register as a sole trader or register your business as a limited company.

Many individuals at the beginning of their self-employed career will set up as a sole trader but as their business expands they may wish to change to a limited company. In this article, our partners at Markel Direct explain the differences between the two business structures, how to switch from a sole trader to a limited company and the benefits of becoming a limited company.

switch from sole trader to limited company

Advantages of being a sole trader

For many individual starting a new business on their own, setting up as a sole trader can feel like the easier and lower-cost option. As a sole trader, you can get started with your business immediately. To register, all you need to do is file one form with HMRC and file a tax return each year thereafter.

Unlike with a limited company, you don’t need to register a trade name and you can more easily make business decisions without restrictions. One of the key benefits to being a sole trader is that all profits after tax belong to you. Accounting and tax can also be simpler too if your profits are reasonably low.

Disadvantages of being a sole trader

Generally, a sole trader is the only person involved in the running of a business however it doesn't mean you can't take on employees. It just means you are responsible for your business. In fact, legally, you and your business are not separate entities. As a sole trader, you are your business. On the upside, this means all your earnings after tax belong to you. However the disadvantage to this is that you are personally responsible for any business debts or losses, meaning if your business faces financial troubles, your personal possessions including your home, car and personal savings are at risk.

How does a limited company differ from a sole trader?

Unlike a sole trader, a limited company is often owned by more than one shareholder and managed by multiple directors. As the business owner, you can decide to be both a shareholder and a director so you stay in control of the business.

A limited company is its own independent entity, separate to its owner. Legally this means as the business owner, your personal assets such as your house, car, savings and so on, are not associated with the company, meaning if your company is sued, you have more protection. It also means that profits made belong to the company rather than you personally and therefore you need to be paid as an employee.

Switching from being a sole trader to a limited company, comes with some additional responsibilities including:

  • Submitting financial records each year to Companies House (rather than HMRC)
  • Hiring a business secretary – to oversee what is happening within your business and be willing to countersign paperwork
  • Setting up PAYE
  • Managing your company's resources and finances.

If you’re a company director, you will also need to agree on a list of terms. For example:

  • Who is responsible for which parts of the business
  • How things will be managed if someone leaves the company
  • How the business will be divided if you sell
  • The sum each director will receive from profits.

Advantages of having a limited company

As we mentioned above, one of the main benefits to registering your business as a limited company is not being personally liable for any financial troubles your business encounters. This means that even if your business goes bankrupt or owes money, your personal possessions won’t be affected.

Another potential benefit, is that with a limited company you may end up paying less tax. Limited companies must pay Corporation Tax at 19 per cent on its profits whereas a sole trader will pay 20 to 45 per cent income tax.

If you are a director and shareholder of your firm, you can decide to take a small salary and pay yourself mostly in dividends. This can lower the amount of National Insurance you’re required to pay, as limited companies don’t have to pay tax on dividends. All in all, paying less tax could allow you to put more money into growing your business.

While sole traders are limited to what they can expense, limited companies can claim VAT back on a wide range of business expenses such as equipment, phones, travel, office supplies, internet and more.

Some other benefits to having a limited company include your business name being protected and building more trust with your customers as it’s thought that people tend to put more trust in limited companies than they do sole traders.

How do you switch from a sole trader to a limited company?

You may want to speak to your accountant if you have one to make them aware of your plans so they can provide guidance if needed.

If you decide that it’s the right time for you to change from a sole trader to a limited company, you’ll need to take the following steps:

  1. Firstly, you must form the limited company. To do this, you need to decide on a name that isn’t already trademarked or taken.
  2. Next, you need to choose your directors, the shareholders and anyone else who will have substantial control of the business.
  3. There will be a number of forms you’ll need to prepare such as a 'memorandum of association' and 'articles of association'. For guidance on how to complete these forms visit the website here.
  4. Register an official address and choose the right SIC code (Standard industrial classification of economic activities) for your business.
  5. Now 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 through Companies House.
  6. Inform HMRC that you are no longer a sole trader and request for them to deregister you.
  7. If you have an accountant, let them know of the changes so they can complete your tax and accounting needs appropriately.

Ensure that you complete all the steps and paperwork required. It’s important to note that there are fees associated with setting up a limited company however these are usually not too expensive.

If you do decide to switch from being a sole trader to a limited company, it may be worth seeking professional advice to ensure you are making the right decision for your business.

As an IPSE member, you can enjoy a 10% discount* on professional indemnity insurance from Markel Direct. Get a quote here.

*IPSE 10% member discount terms and conditions

The discount will be applied to the net policy premium before insurance premium tax is applied. All quotations provided will be subject to meeting underwriting and claims criteria acceptance. All cover will be subject to full policy terms and conditions which are available upon request.

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IPSE have partnered with Markel Direct, a specialist insurer of contractors, freelancers, self-employed professionals and micro-businesses to offer a 10% discount* on contractor insurance to IPSE members.

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