One of the key decisions for any business owner is whether to run as a Sole Trader or Limited Company. The answer, invariably, depends on the circumstances of you and the business at that particular time.
However, over time, those circumstances may change. In this instance, you may consider changing the formation of your business from Sole Trader to a Limited Company. If that’s the case, then our handy guide to the switch from Sole Trader to Limited company will be perfect reading for you.
The Difference between a Sole Trader and Limited Company
Before we go into the switch, it is important to define the differences between a Sole Trader and Limited Company. A Sole Trader consists of the individual responsible for the business. It’s a simple way of running the business and means it is quite easy when it comes to tax returns. Setting up a Sole Trader business is straightforward; you can simply do it via the gov.uk website.
A Limited Company, on the other hand, is its own legal entity, and is therefore separate from its owners (unlike a Sole Trader business). Multiple people in this instance can run or own a Limited Company.
The main benefits of a Sole Trader business are that it is very easy to set-up and has little paperwork. In fact, the only document you’d need to file would be an annual self-assessment tax return.
Furthermore, your details are kept relatively private as there is no need to register your address and name with Companies House.
The disadvantages are that a Sole Trader business has unlimited liability, so if the business is in debt, then you as the business owner could be personally liable, leading to a potential loss of your own assets such as your house or car.
Additionally, if you reach higher levels of earnings, then the tax rates are worse than if you were a Limited Company.
These disadvantages can be offset if you form a Limited Company instead. A Limited Company has limited liability and tend to be more tax efficient than Sole Traders, as you can pay yourself Dividends which are subject to a lower tax rate.
However, Limited Companies are subject to more responsibility and paperwork. You’ll also need to register with Companies House and there is a fee to incorporate your business.
Why You Should Switch To A Limited Company
When you start out, it is typical that your earnings are low. In this phase, it may be best to stay as a Sole Trader. However, as your earnings increase, it becomes more beneficial to switch to a Limited Company. This will decrease your Corporation tax liability, as well as improve the image of your business. Many clients may prefer to work with a Limited Company.
When you hit a higher income, it is time to switch to a Limited Company. With a Limited Company, the way you are paid changes. Instead of just taking an income from the profits of your Sole Trader, you take a combination of a Salary and Dividends. Taking a salary is an allowable expense, so will cut down on the corporation tax you pay. Dividends are taxed at a much lower rate than income tax, so you will save a lot here.
How To Switch From Sole Trader To Limited Company
One of the first things you’ll need to do is set-up a business bank account. As mentioned, with a Limited Company you will not personally be liable for any debt within the business. Therefore, it is good practice to have a separate business bank account to handle expenses and income relating to your business.
You’ll then need to notify HMRC that you have switched from a Sole Trader to a Limited Company. This is because your tax payments will change. You’ll then need to form a Company on Companies House, incorporating your business name and creating a memorandum and articles of association.
Ensuring you have a good accountant onboard to help guide you through this process. This is especially important as you move into a Limited Company, as there is much more paperwork to submit and compliance is important to ensure you don’t receive any HMRC fines. Incorporating accounting technology into your business can help deal with the minefield of paperwork and simplify invoicing, bookkeeping, expenses and payroll.
If business is booming and profits are growing, it may be time to switch from Sole Trader to Limited Company. This will help reduce tax liabilities, as well as help you fast track growth by employing others to help you on your journey. Don’t be daunted by the switch, speak to iFinance Department for a free initial consultation, with tailored independent business financial advice that can help accelerate your business.