Many businesses start as sole traders, as it’s usually the most straightforward way to start a business in the UK. However, when it comes to growing your business, you may decide that you want to change to a limited company.
Broadly speaking, limited companies are more tax efficient than sole traders, because rather than paying Income Tax they pay Corporation Tax on profits which means that forming a limited company can be more profitable.
If this is something you are considering, we have put together some information to explain the differences, the benefits, and how you go about making the change…
What is the difference between a sole trader and limited company?
- A business owned and controlled by one self-employed individual.
- No legal distinction between the sole trader and the business, meaning a sole trader has unlimited personal liability for all business debts, losses, and legal claims.
- Personal finances and assets are at risk if you cannot pay business-related debts, or if you are sued.
- All business income belongs to you.
- No information about you or your business is made available to the public.
- You must register for Self-Assessment.
- You must submit a Self-Assessment tax return to HMRC every year.
- A business owned by one or more shareholders and managed by one or more directors.
- The same person can be a shareholder and a director, so you can either own and control the business by yourself or jointly with other people.
- It is the limited company rather than the shareholders and directors that is liable for any debts, losses, and claims brought against the business.
- All business income belongs to the company until it is transferred to you as a director’s salary, expenses, shareholder dividends, or a director’s loan.
- Company information such as accounts and certain details relating to directors and shareholders is available to the public
- The company must register as an employer and set up PAYE, even if you are the only employee.
- A company Tax Return must be submitted to HMRC each year.
How do you change from a sole trader to a limited company?
If you decide to change from sole trader to limited company, you will need to do the following:
1. Register a limited company
You can register your limited company online, with most applications processed and approved by Companies House within a few working hours.
To register a limited company online, you will need:
- a unique company name
- registered office address
- at least one director
- at least one shareholder
- service address for each director and shareholder
- Standard Industrial Classification (SIC) codes to describe the nature of your business activities
2. Tell HMRC you are no longer a sole trader
When your new limited company has been incorporated and you are ready to start trading as a limited company, you will need to tell HMRC that you are stopping self-employment by completing an online form with the following details:
- Date on which you stopped being self-employed
- Unique Taxpayer Reference (UTR)
- National Insurance Number
- Date of birth
- Nature of trade
You will need to submit a final Self-Assessment tax return by 31st January after the end of the tax year to include your self-employed earnings and tax liability up to the date that you stopped being a sole trader.
3. Transfer your sole trader business to the company
You may need to transfer existing business assets (property, machinery, equipment, etc.) to your new limited company. If your new company does not have the funds to pay for these you can create a director’s loan account where the company will pay you for the assets over time.
This may trigger Capital Gains Tax liability, which is based on the market value of the assets. Depending on your circumstances, you might be able to reduce or defer CGT by claiming some form of tax relief, such as Incorporation Relief, Business Asset Disposal Relief, or ‘Hold-over’ Relief.
4. Set up a business bank account in your company name
It’s a good idea to set up a business bank account to keep your business finances separate from your personal finances. This makes bookkeeping easier and avoids the risk of taking money out of the company illegally.
5. Notify stakeholders about the change of business structure
When changing the legal structure of your business the stakeholders that you will have to notify include:
- Employees and contractors
- Banks, lenders, and other finance providers
6. Register your limited company for tax and PAYE
Once your new limited company has been incorporated, Companies House will inform HMRC and you will receive a letter at your company’s registered office address within approximately 2 weeks with information about your tax and reporting obligations, as well as your company’s 10-digit Unique Taxpayer Reference (UTR).
You need to register your company for Corporation Tax online within 3 months of trading as a limited company.
If you expect your VAT taxable turnover to be more than £85,000 within a 12-month period, you must also register for VAT. If you are already registered for VAT as a sole-trader, you must cancel this within 30 days of changing your business structure.
To receive a director’s salary and pay any employees, you need to register as an employer and set up Pay As You Earn (PAYE) before the first payday.
Changing from a sole trader to a limited company can be a complicated process, so if this is something you need assistance with, feel free to get in touch with us here at Magpie Accountancy.