The simplest and most common way to start a business is as a sole trader. It is flexible, has minimal paperwork and easy tax reporting. However, once your business grows you may find wanting to change over to a limited company. This move adds to the responsibilities but also provides tax efficiency, credibility and financial security. Accountants for limited company are available to guide you through the process.
If you are thinking about this transition, it is necessary to understand its implications as well as the steps involved. In this guide, we’d show you what you need to think through before moving from a sole trader to a limited company and the pros and cons of doing so.
Understanding the Key Differences
Sole Trader: Simplicity and Direct Control
If you are a sole trader, legally, your personal and business finances are the same. You are personally liable for all profits, losses and liabilities. This offers simplicity of setup without a lot of extra administration, however, it comes with no limit to your personal liability (i.e. your personal assets could be at risk if the business gets into debt).
Limited Company: A Separate Legal Entity
An other hand a limited company is a company that legally separates itself from the owner(s). Debts and liabilities belong to the company not to you (unless you personally gave a guarantee). The setup, though more involved, has protection, tax benefits, and earns you a higher level of credibility.
Why Make the Switch? Limited Company Benefits
Limited Liability Protection
Protection remains one of the main reasons to incorporate. If your business runs into money troubles, as a sole trader you could lose your own home and savings. A limited company protects you from personal liability so that only the company’s assets are used to settle debts.
Tax Efficiency and Savings
Most limited companies enjoy more favourable tax treatment than sole traders. A company pays Corporation Tax instead of Income Tax on all profits, and Corporation Tax is normally less than personal rates of tax.
Furthermore, you can structure your income tax efficiently by having a small salary and the rest as dividends. This approach can provide a much reduced personal tax bill because dividends are taxed at lower rates than salary.
Greater Business Credibility
The presumption of ‘stability and professionalism’ of limited companies is a great reason that many larger clients and suppliers prefer dealing with one. The truth is that some organisations don’t want to work with sole traders, only incorporated businesses – and this gives you the chance to uncover new opportunities that wouldn’t have been open as a sole trader.
Easier Access to Funding and Investment
Limited companies are usually more likely to attract banks and investors to fund them. As a limited company, it is easier to attract investors as you can issue shares, meaning that they will own a portion of the business. Besides, applying for business loans or credit facilities will be easy.
More Efficient Profit Retention and Reinvestment
Unlike sole traders, limited companies can retain profits within the business without being hit with high tax rates immediately. As such, this enables reinvestment into business expansion, equipment or hire employees without big tax penalties.
Potential Capital Gains Tax Benefits
Operating as a limited company has tax benefits if you intend to sell your business in the future. Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) can help reduce the level of Capital Gains Tax payable on eligible sales of a business as this is a comparatively more financially efficient means of exiting a business.
Challenges and Responsibilities of Running a Limited Company
The benefits are considerable but there are also other responsibilities and compliance requirements when you convert to a limited company. You should be ready for the following:
Increased Administrative Burden
Strict reporting requirements apply to limited companies. This includes:
- Companies House registration of the business.
- Filing annual financial statements
- Submitting Corporation Tax returns
- Maintaining detailed company records
Business structure for sole traders is much more easy to manage as sole traders have far fewer regulatory obligations.
Separate Business and Personal Finances
Unlike sole traders, limited company directors can’t take business profits as personal income whenever they want. Dividends are favorable in taxation however they must be distributed in accordance with the profits of the company and have noticeable documentation.
Accounting and Legal Requirements
Company directors have to follow certain legal obligations such as ensuring the company is solvent and filing accurate financial reports. However, many businesses decide to employ an accountant to handle these matters and this implicates additional operational expenses.
Corporation Tax and Payroll Duties
Once you have started to trade with a limited company you have to register with HMRC for Corporation Tax. In addition to this you will need to establish a payroll system and abide by PAYE (Pay As You Earn) rules if you have employees (including yourself as a director if you will receive a salary).
Contact accountants for limited company for a better grasp on the topics.
How to go from being a Sole Trader to a Limited Company.
If you have done the work to determine that incorporation is right, this is how you proceed.
Register Your Limited Company
- Select a company name (it has to be unique and adhere to Companies House guidelines).
- You should appoint at least one director (yourself or others).
- Decide on company shareholders and share structure.
- Go to Companies House and register and obtain a Certificate of Incorporation.
Close Your Sole Trader Business and Inform HMRC
When your company has been officially formed, you have to tell HMRC that you are no longer a sole trader. You will also have to file a final Self Assessment tax return and pay any outstanding tax liabilities.
Open a Business Bank Account
Since a limited corporation is a separate legal entity, it needs its own bank account. This will ensure that business and personal funds are separated.
Corporation Tax and VAT (if applicable)
You are required to register for corporation tax within three months of starting operating your business. Moreover, if your yearly turnover exceeds the VAT level, you will have to register for VAT.
Consider Tax Efficient Salary Structures and Set Up Payroll
It is important that if you are planning to pay yourself a salary, then you register the company as an employer and set up a PAYE scheme with HMRC. Most business owners choose to mix salary and dividends to optimise tax efficiency.
Make an update on Contracts, Invoices and other Business Records
Make sure all the existing business contracts, invoices, and agreements have your new company details. The transition must be informed to suppliers, clients and partners.
Is Incorporation Right for You?
There are many factors that determine whether a sole trader should become a limited company, such as financial goals, risk tolerance and long term business plans. If you’re uncertain if incorporation is something you need, accountants for limited company can help you to understand if or not incorporation is something that makes sense for your business.