Changing from a sole trader to a limited company: what do you need to do? 

You may consider changing from a sole trader to a limited company, but what would this involve? 

We reveal the difference between a sole trader and a limited company, why you might want to switch, the process, costs, and pros and cons. 

What is a sole trader? 

If you own your business solo and are self-employed, you are considered a sole trader. Examples of sole traders include freelancers, gig economy workers, and tradespeople.  

Being a sole trader means you fully control your business, and there are no shareholders or directors; plus, you benefit from all profits after tax. You’ll pay income tax, national insurance, and may pay VAT. 

While this is appealing, it means sole traders have ‘unlimited liability,’ meaning they are personally liable if they or the company is sued or becomes insolvent. In such cases, they must pay any damages. 

Sole traders can start trading without registering for self-assessment unless they earn more than £1,000 in a tax year and must submit tax returns.  

What is a limited company? 

A limited company differs from a sole trader as it is a business structure that is a separate legal and financial entity from the individuals running the company. 

This means you’ll have limited liability, meaning if the business becomes insolvent or is sued, you’re only liable for your investment in the company. Essentially, your personal assets are protected.  

Other factors that set a limited company apart from a sole trader include having at least one director, a bank account, and being registered at Companies House.  

Limited companies must pay corporation tax, national insurance, and VAT, and the company can be bought and sold via shares. 

Limited company directors will also still need to file for self-assessment. 

Why would a sole trader want to become a limited company? 

There are many reasons why a sole trader may choose to become a limited company, including: 

• Limited liability: As the finances and liabilities of a limited company are separate from shareholders and directors, they have limited liability. If the business is made insolvent or sued, they are liable for their share or investment, and personal assets are protected. 

• You want to bring in a director or shareholders: Sole traders can only be owned by one person, but with a limited company, directors and shareholders can also join.  

• Perpetual succession: A company will continue to exist and operate after the owner or shareholders pass away. If a sole trader passes away, the business will no longer exist.  

• You may pay less tax: Corporation tax is lower than income tax rates, which can be up to 45%, meaning you may have a smaller tax bill. You could also choose to pay yourself in a more tax-efficient way via a small salary and dividends. Additionally, you can claim more business expenses.  

• Being a limited company can make it easier to grow: You can bring on directors and sell shares as a limited company. You’ll also likely find it easier to get investment as a limited company compared to a sole trader.  

• Protecting your company name is essential: Limited company names are legally protected under the Companies Act 2006, but sole trader company names are not and must sort this themselves by registering a trademark to protect their brand name.  

It’s worth getting expert advice before changing from a sole trader to a limited company to make sure you understand the changes and if it’s right for you. 

How to change from a sole trader to a limited company 

If you want to change from a sole trader to a limited company, follow these steps: 

1. Have all the necessary information ready 

When you’re planning to register as a limited company, having all the information to hand is essential to help you quickly set up everything. 

Here’s what you’ll need to have beforehand: 

• A company name: You will need to have a company name that is not already being used. There is a company name checker on the GOV.UK site. You need to follow the rules for a company name and include ‘Limited’ or ‘LTD.’ 

• Registered office address and company email address: You need a UK address where mail can be delivered and a company email address. 

• Details for directors and shareholders: Ensure you have any necessary information for directors and shareholders, as well as a guarantor who can be a director. You can appoint a company secretary, but this is not mandatory. 

• Details of people with significant control over your company: This includes anyone with voting rights or owning more than a quarter of your company’s shares. 

• Prepare a memorandum of association and articles of association: These are vital to prepare as they are the basis for agreeing to form a company and include written rules about running the business. A memorandum of association is automatically created if you register online, but you can write your own articles of association. 

2. Register your limited company with Companies House 

You’ll need to register your limited company with Companies House, and you should be registered for corporation tax at the same time. This costs £50, which can be paid by debit or credit card or £71 if you do this by post and pay by cheque. 

If you register online, your company is usually registered within 24 hours, but if you do this by post, it’ll take eight to 10 days.  

When your company is successfully registered, you’ll get a certificate of incorporation that confirms the company legally exists with the company number and date of formation.   

You could also use an agent or third-party software to register, which will cost you money.  

3. Contact HMRC to let them know you’re no longer a sole trader 

When you want to officially stop being a sole trader and start using your limited company, you must tell HMRC you are no longer a sole trader. You can do this via your HMRC account. 

You’ll need your national insurance number and unique taxpayer reference (UTR) number, and you’ll need to send a final tax return and pay any outstanding tax.  

4. Transfer your sole trader business to your new limited company  

You’ll need to transfer over business assets to your new limited company.  

It’s important to note that you may be liable for capital gains tax based on the market value at the time of transfer. 

There may be ways to reduce your tax bill, so it’s worth consulting an accountant beforehand. 

5. Register as an employer and get on top of tax 

You should register as an employer and set up Pay As You Earn (PAYE) if you’re planning on paying any salaries, including for yourself, unless specific criteria are not met. 

The criteria for registering for PAYE is paying an employee at least £96 a week, if they have work benefits or expenses, are receiving a pension, had another job or received certain state benefits. If you don’t need to register, you still need to keep payroll records.  

If you haven’t been registered for corporation tax when you registered your limited company, you must do this within three months of starting trading. 

You must also consider whether to register for VAT, which is mandatory if you expect taxable income to exceed £90,000 annually. You may be able to transfer an existing VAT registration you had as a sole trader. 

6. Open a business bank account 

A business bank account will separate your personal and business finances and keep track of any income and expenses. It also helps ensure you don’t unintentionally spend business funds. 

After you’ve changed from a sole trader to a limited company, you must also notify relevant people, including clients, contractors, and suppliers.  

What are the costs of changing from a sole trader to a limited company? 

It’s free to register as a sole trader, but this isn’t the case for registering a limited company, which costs £50 online or £71 if you choose to do this by post. 

There are other costs to consider, such as insurance policies, ongoing business expenses, an accountant or accountancy software, and possibly legal fees. 

What are the pros and cons of becoming a limited company? 

There are many advantages and disadvantages to consider before becoming a limited company.  

The pros of becoming a limited company 

• Protection of personal assets: If a business is made insolvent or sued, they are liable for company assets while personal assets, including their own home, are protected, but sole traders could lose theirs. However, if there is director misconduct, an individual can be personally liable even if they have a limited company. 

• More prestige: Limited companies may be seen as more stable than sole traders and could benefit from more business opportunities or find it easier to get investment.  

• It may be more tax-efficient: Your company may pay less tax as corporation tax is 19% for profits of under £50,000 or 25% for profits of over £250,000. This is usually lower than income tax, which is between 20% and 45%. Some directors also choose not to pay national insurance by giving themselves a lower salary than the threshold and paying themselves partly in dividends. 

• Legacy planning: With a limited company, the owners are legally separate from the business, so if someone leaves or passes away, it still exists.  

The cons of becoming a limited company 

• A limited company is more complex and time-consuming: You need to register via Companies House and must file accounts, which are freely available, including to competitors. Owners and directors must also meet more legal obligations and deal with more admin, potentially leading to legal action or penalties if they don’t meet requirements. 

• A limited company can be more expensive to run: Due to the admin and reporting required, you may need to face higher costs, such as for staff or an accountant. 

• You’ll need to agree on the company’s direction: As a sole trader, you had complete control over your business and made the decisions. However, limited companies have shareholders who may have ideas about how to run the business.  

• A limited company can be hard to close down: You’ll need the agreement of your company’s directors and shareholders to close a limited company. If your business is insolvent, it can be a more complex and expensive process.   

Get expert financial advice 

Deciding whether to change to a limited company is a major decision and one that shouldn’t be taken without careful consideration. 

Unbiased can quickly match you with a qualified accountant who can help you decide if it’s the right decision for your business.