Sole trader to limited company: a how-to guide

Moving from sole trader to limited company is a big decision, but it could have many benefits for your business. If you’ve operated as a sole trader up until now, here’s a how-to guide to starting a limited company.

Setting up a limited company is the most popular option for contractors and freelancers who are able to do so. In 2017, Companies House reported a 7% rise in the number of actively trading companies – many of these are one-person companies (one director and shareholder).

Here’s how you can switch from a sole trader to limited company, and take your business to the next level.

(Download our FREE guide on moving from sole trader to a limited company director)

How to set up a limited company

As a sole trader, you already know how to run a business on your own, so having a limited company won’t come with a lot of extra work in comparison.

Step 1 – Set up your company, choose a name

Sole traders may operate under a business name, but this doesn’t have to be registered officially. So the first thing you need to do to start a limited company is come up with a company name. Come up with a name that’s memorable and relevant to your industry.

Next, you need to set up your company. You can either do this through Companies House directly for a small fee, through an expert accountant or via a formations agent.

Your company will need a SIC code, which is a classification of the business’ activities. It will also need to have a director (you) and at least one shareholder.

Step 2 – Company bank account

Sole traders aren’t legally required to have business bank accounts. Neither are limited companies, but it’s very important to separate your business finances from your personal finances for tax purposes. You’ll be both a director and shareholder of your company, so setting up a business bank account should be high on your priorities. Accountants can help you set up business bank accounts and usually work with trusted and well-known providers.

Step 3 – Tell HMRC

When you stop self-employment (operating as a sole trader), you need to tell HMRC for tax and National Insurance purposes.

HMRC might expect you to file tax returns to wind up your self-employed business. Going forward, you’ll be expected to complete tax returns as a company director (Corporation Tax Returns and VAT Returns – if VAT registered) and a yearly Personal Tax Return as a shareholder.

Step 4 – Update your stakeholders

It’s standard practice to let stakeholders of your business know that you intend to move from sole trader to limited company. Stakeholders may include clients, service providers for your business, and any creditors you have. This is done simply to minimise any potential confusion with invoicing and paperwork.

Step 5 – Register your company for tax

Your company set up can be done in as little as 24 hours. Once this is complete, you need to register it for Corporation Tax, PAYE and VAT (if required). You must register for Corporation Tax within three months of trading. It requires you to pay company tax on any profits your business makes in a tax year.

You also need to register for Pay As You Earn (PAYE) so you can pay your National Insurance and income tax when its due.

Register your company for VAT if its VAT taxable turnover is £85,000 or more, or if you wish to register voluntarily. This requires you to pay VAT (20%) on your VAT taxable invoices but also lets you reclaim VAT where applicable.

Sounds confusing? An accountant can help you make sense of how company taxes work, and even help register your business for tax and advise you how much tax you need to pay and when.

Step 5 – Start trading

Once you’ve completed the above steps to set up your company, you’re ready to start trading. You can invoice your clients through your accountant or invoicing software, and hold back any tax and National Insurance you’ll owe upon submitting your tax returns. Other paperwork you’ll need to complete includes ongoing bookkeeping for your company, a yearly Confirmation Statement and your year-end accounts, to name a few.

If you’re used to paperwork as a sole trader, this should be fairly straightforward. However if you ever need support, there are accountants that specialise in providing full-range services to single-person companies.

Take a look at our limited company accountancy packages to see which might suit your needs.

Why set up a limited company?

If you’re comfortable operating as a sole trader, you might be asking yourself why give yourself more work by setting up a limited company?

There are several benefits to being a director of your own company:

• Limited liability – you are not personally liable for any financial losses of your company, offering protection to your personal finances and livelihood. Sole traders are personally responsible for their business’ debts and liabilities.
• Tax efficiency – as a company director and shareholder, you can have the option to pay yourself through a combination of salary and dividends. Dividends are not subject to National Insurance, whereas all of your income as a sole trader is subject to both income tax and NI. Sole traders also pay Class 2 and 4 National Insurance Contributions (NICs), whereas companies will pay only Class 1
• Flexibility and options – having your own distinct entity as a business can open you up to more work opportunities. Recruiters will often refuse to work with sole traders due to liability, and having a limited company will give you more credibility with most clients.
• Tax planning – limited companies allow you to save tax and plan for the future, for example by enabling you to have a company pension. It will allow you to save for the future and save tax now by funding your pension as a business expense.

Thinking of setting up a limited company? Get started today by requesting a callback – or find out more about accounting for limited companies.