Many entrepreneurs start their business as a sole trader, but want to grow and take on more staff. As your company grows, you may find that it makes sense to make the change from being a sole trader to becoming a limited company. You are not alone in this decision, and many businesses incorporate for practical reasons, such as employee benefits or tax planning. However, there are many considerations which need to be made before you form your limited company, not least of which is whether you can transfer your assets over to your new company. This can have various legal and tax implications so it is very important that you know the correct procedures to follow.
This article will explain what is required when changing from a sole trader to a limited company, and how to transfer your assets legally and cost-effectively.
What is a sole trader?
A sole trader is an individual with no formal legal structure that carries out business. Sole traders can be freelancers, consultants, contractors or one-person businesses operating in a specific field. The main benefit of being a sole trader is freedom from both shareholders and directors who may disagree with your vision for how to run your company. Other benefits include less paperwork, less formality in the management of your business, and a potentially lower tax bill. The potential downsides of operating as a sole trader are a lack of access to borrowing and a higher level of personal liability.
What is a limited company?
A limited company is a separate legal entity that provides you with protection against personal liability when it comes to debts incurred by the company. A limited company can be used for many different purposes such as starting a new business or protecting an existing one from losses.
The main benefit of being a limited company is being able to limit your exposure to paying off creditors if you go bankrupt due to financial difficulties. Other benefits include more credibility with customers and suppliers, better access to external financing (e.g., bank lending), wider investment opportunities and certain taxation advantages.
Some people may be worried about the additional costs of being a limited company, such as setup fees and annual accounting charges to cover audit work. In reality, these are minimal compared with the advantages that you will receive by becoming a limited company.
What are the benefits of changing from a sole trader to a limited company?
People choose to change from a sole trader to limited company for many reasons. One common reason is to secure a source of funding other than personal savings or loans. This is because the rules around borrowing money as a sole trader can be complicated. With a limited company, you can have a shareholders agreement set up before accepting any outside investment.
Another common reason people make the change is when their circumstances have changed such as when they become self-employed after being employed, or vice versa (known as “deemed employment”).
In some cases, people may also change to a limited company because they want to simplify the management of their small business. Operating as a limited company means that you can appoint directors with limited responsibility and liability who are not involved in day-to-day operations.
As with any business, the key consideration for sole traders is whether they can realistically take on all the responsibilities that are associated with running their company without external support or help. If not, then converting from being a sole trader to limited company may be worth considering as it could make everything easier, from dealing with suppliers to collecting money from customers.
What are the tax and legal implications of changing to a limited company?
The tax implications of changing to a limited company can be both good and bad. The main difference is that as a sole trader, you are able to offset your personal expenditure against business profits (e.g. buying new clothes for work). This profit will now need to be taxed unless it’s spent on items essential for running the business such as equipment or advertising costs (if they’re not already being claimed back from HMRC under another scheme like VAT cash accounting). It may also affect things like inheritance tax, and stamp duty land tax.
What is the process of changing to a limited company?
The process of changing from a sole trader to a limited company can be more difficult than you might expect.
- The first step is getting all the assets transferred into your new name, which may require you to go through some red tape with HMRC and Companies House.
- After that, you will need to file documents about the transfer at both Companies House and HMRC in order for them to update their records accordingly. In order to do this, you will first need form ‘CT600,’ which acts as an estimate of your income tax liability for the current year. You will then set up a new account with HMRC called “SWITCH” (a service provided by HMRC to allow sole traders to transfer their assets into companies). You will need to fill out form CAA105 before you can start the process of changing your status.
- Finally, you will need to provide your employees with information on how this change affects things like paychecks or pension contributions. Remember that even if pensions are no longer payable as they were before (due to legislation changes), it’s still important for people to understand what these difference mean for them so they don’t feel cheated out of something they rightfully earned during their employment.
What kinds of assets are usually transferred?
Unless you have already been a limited company, the most common types of asset that would be included in your application are going to be money or property. However, what this property is will depend greatly on what industry you are in. For example, if you are an accountant, then assets like cash accounts will be transferred over to your limited company. However, if you were running a barber shop, then the assets are likely to be property such as chairs and equipment.
Once these items have been formally transferred into your name through the process explained above, not only do they become fully owned by yourself again and officially part of your new business, they are also given an increased level of protection as a result.
In the event that any assets were originally purchased by more than one party, you will need to make arrangements with the other party prior to changing the structure of ownership.
If any intellectual property or trademarks are being transferred, then an attorney should be consulted before making the switch so that all necessary documents and agreements can be drawn up for these items.
Which assets are subject to UK capital gains tax (CGT) when switching?
There are various assets are subject to UK Capital Gains Tax (CGT) when changing from a sole trader to a limited company. These include shares, property, and land that is not being used for business purposes. Shares can be transferred at the market price of the share on the date it was acquired or their value in cash if this figure is greater than its original purchase price. The transfer must also meet certain conditions, including having been held as an investment rather than through trading activity during any previous period as a sole trader.
What are the potential reliefs from CGT?
Incorporation Relief – This is available to people that have started a new business, or are taking over the assets of an existing one. It’s often used by individuals who want to transfer ownership from sole trader status. The relief allows for postponing CGT liability until you sell your shares in the company (or holdings) and so it can help with cash flow problems while you’re starting out as owner-operator.
Entrepreneurs’ Relief – This applies if at least one person owns more than 25% of the company when transferring into limited company status. This means there will be no capital gains tax charge on those transferred assets because they qualify for 100% exemption under section 109 TCGA, 1992.
‘Hold-over’ Relief – This applies if you have started trading with some assets before the date on which your company changes from a sole trader to limited company. In this case, HMRC would not charge CGT for those specific assets that are being transferred over.
What are the common difficulties encountered when switching to a limited company?
The first issue some sole traders run into is that the assets to be transferred were not originally owned by them. If you are in this position, it is necessary for a formal legal process called an “assignment” to take place before those assets can be transferred. This may also involve updating any documentation that reference the assets from when they were still in the possession of their original owner, and then transferring them over into your name. The reason for this formality is that if there was no legal document that assigned ownership of the assets to you, there would be nothing to stop someone else coming along and claiming them.
The other difficult that is often encountered when changing from sole trader to a limited company is with tax records. When you become a limited company, it means that all income and expenses relating back to your business are now going through an official entity, whereas they were previously just handled by yourself as a sole trader. This will mean substantially more paperwork and tax forms which can be tricky if you’ve never had to do them before.
Top tips for changing from a sole trader to a limited company
- Talk to an accountant and a lawyer who understand the implications of changing to a limited company for your business type and take their advice on any legal or tax aspects.
- Assess what assets need transferring: shares, land/property and decide whether it is worth getting an estimate or valuer (this can be expensive).
- Decide on a date to change over – the sooner you do it, the more time you have to plan your tax position and get everything in order.
- Get all paperwork together so that when the day comes for changing over, there is no last minute rush or panic with missing documents.
- Learn about any new regulations that may apply after becoming limited company: accounting requirements, VAT etc and make sure these are being met before transferring assets.
- Consider transferring intellectual property and trademarks.
- Find out which assets are subject to UK Capital Gains Tax charges.
- Take care before assigning any assets that were not originally owned by you, as a formal assignment process might have to happen first in order for the transfer to take place correctly.
Where can you get advice before making the switch?
There are a number of places you can get advice before making changing to a limited company. One option is to contact an accountant or a lawyer, who will be able to advise on the legal and tax implications of your change in status. Another option is talk to an organisation such as The Association for Legal Professionals (ALP), which offers free expert support from qualified accountants, lawyers and HR experts. There are also websites like Company Wizard that provide information about how to set up a limited company or sole trader in the UK.
To sum up
Changing from a sole trader to a limited company can have many benefits, but in order to transfer all your assets correctly, you need to follow the correct steps. Make sure that all documents pertaining to ownership of your assets are in order, and that you have checked the tax regulations regarding each type of asset you plan to transfer. If this is your first time starting a limited company, it may be worth spending a little money on a lawyer or accountant (or both) who will be able to guide you through the process.