Making The Switch from Sole Trader to Limited Company

Many people start off contracting or freelancing as a sole trader due to the easier and cheaper set up process compared to setting up as a private limited company. Over time when your business develops you might realise you are ready to change from a sole trader to a limited company structure to be more efficient.

A reason to transition to a limited company includes that over time when earnings increase, being a limited company means that you have to pay less tax when your sole trade profits reach around £30,000 a year. The switch also gives you the flexibility to involve others in your business to help it grow – including directors and shareholders.

Other benefits of becoming a limited company include:

  • limited liability
  • greater borrowing power
  • improved reputation
  • credibility

To set up a Limited Company you need a separate bank account in the business name. This is because of tax consequences you may incur.  As a sole trader, all of your profit is taxable to you. Whereas a limited company, you are taxed personally on the money you take in your salary and dividends. Any other money from the account that you take will act as a director’s loan with HMRC rules. You should also be aware that income is processed differently as being a private limited company, personal income will be a combination of a director salary and dividends (profit after Corporation Tax).  Since the tax will be calculated differently, to avoid confusion having a personal and business account separate is useful.

For a sole trader, you have to submit an annual Self Assessment to HMRC so they can calculate what Income Tax and self-employed National Insurance you needed to pay. Whereas being a limited company director, on top of filing an annual Self Assessment tax return, but also a regular payroll (normally monthly) for any salary you choose to take. It should be noted that you may not need to pay Income Tax or National Insurance on the salary, depending on how much you decide to take out. However, you will need to declare any dividends you receive from your limited company as well as all the sources of income you have. As the limited company director, you need to file various tax returns to HMRC and Companies House as well as paying the company’s Corporation Tax Bill.

Other changes that you should be aware of include:

  • business expenses are treated differently (option to claim tax relief)
  • choosing the director
  • transferring assets to your limited company
  • Corporation Tax
  • IR35 (tax legislation to combat tax avoidance from workers)

Once you have made the decision to change to a Private Limited Company, you need to make HMRC aware of who the director is as the tax payments will change. The best way to ease with the change from sole trader to a Private Limited Company is an effective accountancy firm backing you. The key role of an accountant is ensuring the limited company is set up best for you with the use of up-to-date technology. With reminders of important tax deadlines and payments, the help of a professional will help you stay tax efficient.

For more in-depth information on the differences between being a Sole Trader and Limited company, read our Sole Trader Vs Limited Company article here.

For help setting your limited company, or for general advice to help your business be as tax efficient as possible, get in touch with us at hello@bkplus.co.uk