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Transferring business from sole trader to a limited company

Transferring business from sole trader to a limited company
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Many businesses begin their life as a sole trader, with just one person working on a self-employed basis. However, if your business really takes off and begins to enjoy large amounts of success, there may come a time when you begin to think about transferring business from sole trader to a limited company. But how exactly do you go about doing that?

In this article, we’ll talk you through the process of converting from a sole trader to a limited company, as well as all of the facts you need to know before making that choice.

Making the right choice for your business

Before you make the decision to convert your small business into a limited company, you need to understand the key differences between a sole trader and a limited company, as well as the pros and cons of each. This will enable you to make an informed decision about the right way forward for your business.

Read on to learn everything if you’re thinking about transferring your business from a sole trader to a limited company.

What is a sole trader?

If a business is run as a sole trader, this means that one self-employed individual both owns and controls the business. From a legal stance, the business does not have its own legal identity, meaning that the self-employed person and the business are essentially the same thing.

This has both pros and cons. On the one hand, the sole trader has full control of their business. Therefore, any profit made by the business legally belongs to the self-employed individually, and they do not need to seek permission to withdraw money from the business.

However, since the self-employed individual and the business are essentially the same thing, this means that the individual also takes on the risk of the business. If the business falls into debt, that debt will be the responsibility of the self-employed individual, who will be liable for paying them.

As a result, sole traders need to be aware that their personal finances and assets, including savings, property and personal possessions are at risk if they become unable to pay business debts or in the case that a claim is brought against the business. This could even lead to personal bankruptcy, should the individual to unable to meet payments.

What is a limited company?

In contrast, a limited company exists as a legal entity in its own right and is owned by shareholders. The limited company may be managed by a single director, or by several different directors. One single person can be the sole shareholder, as well as a director, meaning that you can choose to own and run the business alone, just as you do with a sole tradership. However, you also have the option to run the business alongside other people.

As a limited company is its own legal entity, this means that it holds liability for its own debts, along with any claims that may be brought against the business. Therefore, the finances and liabilities of the business are entirely separate from those of the company’s directors and shareholders.

This means that company owners cannot be held responsible for any liabilities, aside from their investments in the business. As a result, their personal assets and finances remain protected should the business get into trouble.

Sole trader vs limited company

Sole trader vs limited company: Which is right for you?

There are a few key differences that you’ll need to be aware of before making your decision as to whether to operate as a sole trader or a limited company.

We’ve already discussed the differences in ownership and liability when it comes to sole trader vs limited company. There is no legal differentiation between a self-employed individual and the business operating as a sole tradership, meaning that the individual is responsible for any debts incurred by the business. In contrast, a limited company is a separate legal entity, meaning that debts are held by the company itself, with limited liability being placed upon shareholders.

This legal standing also means that as a sole trader, all business income belongs to the self-employed individual. Conversely, with a limited company, profits legally belong to the company until they are transferred out as a director’s salary, expenses or shareholder dividends.

It’s also important to note that as a sole trader, you are self-employed. This means that you file an annual self-assessment form to declare profits and pay income tax and National Insurance contributions through this method. In contrast, as a limited company, directors are employed by the business and receive a salary. Income tax and National Insurance contributions are paid through PAYE, whilst the business will also pay Corporation Tax.

As a result, many people find that a limited company is a more tax efficient way to run a business. Corporation tax is a flat rate of 19%, whilst Income Tax paid by sole traders is 20% – 45% depending on income.

Directors are also able to minimise their own tax and National Insurance contributions by paying themselves through a mixture of both salary and dividends. This tax efficiency is one of the main reasons why many people choose to transfer their business from a sole trader to a limited company.

However, the decision between running your business as a sole trader or a limited company isn’t always easy. If you’re unsure which option is right for your business, we’d always recommend seeking advice from a qualified accountant, who can help you to weigh up your options and choose the right path for your business.

How to convert your business from a sole trader to a limited company

Many people choose to convert their business from a sole trader to a limited company after realising the success of their business. It could be that your are tempted by the tax benefits of running a limited company, or are craving the security of the limited liability that a limited company brings.

Whatever your reasoning, you need to know how to convert your small business from a sole trader to a limited company. In this section, we’re going to talk you through the steps that you’ll need to take to do exactly that.

1.     Register as a limited company

First things first, you’ll need to register as a limited company with Companies House. This is a relatively straightforward process and most applications are approved within just a few business hours.

To be able to register your limited company, you’ll need to have:

  • A unique name for your business
  • A registered business address
  • Details of directors (minimum one)
  • Details of shareholders (minimum one)
  • A Standard Industrial Classification (SIC) code which describes the nature of your business

2.     Inform HMRC that you are no longer a sole trader

Once your business is incorporated as a limited company, you can then inform HMRC that you are no longer operating as a sole trader. You can do this by completing an online form on the HMRC website.

You’ll need to provide details such as:

  • Unique Taxpayer Reference (UTR)
  • National Insurance Number
  • Name
  • Date of birth
  • Address
  • Date that you ended self-employment

You’ll also be required to file a final self-assessment tax return after the end of the tax year. This will declare your self-employed earnings until the date on which you ceased being self-employed.

3.     Transfer assets to the limited company

Next, you’ll need to transfer any business assets to your limited company. This includes any property, inventory, machinery and equipment that you own. The chances are your new business will be unlikely to have sufficient funds to pay for these assets. The most common way to deal with this is by creating a director’s loan account for the company to pay for the assets over a period of time.

It’s important to note that you may be liable for Capital Gains Tax if certain assets are transferred. This will be calculated from the market value of the transferred assets. It’s best to contact a qualified accountant for advice on this, as it can sometimes be a complex process and mistakes could be costly.

Open business bank account

4.     Open a business bank account

When you’re operating as a sole trader, you are not legally required to have a separate bank account for your business finances (although it is recommended). However, limited companies are a separate legal entity, making it compulsory for your business to have its own bank account.

Therefore, you’ll need to ensure that you set up a bank account for your business, ensuring that you keep its finances completely separate from your own at all times.

If you change your bank account details, you’ll need to ensure that you update customers, suppliers and debtors who may hold your account information, as they may need to update their records.

5.     Inform stakeholders

There are several different stakeholders that you will be required to inform of the new legal structure of your company. These include:

  • Customers
  • Employees
  • Contractors
  • Suppliers
  • Landlords
  • Banks and lenders
  • Debtors

This will help to avoid any potential confusion later down the line, whilst ensuring that any invoices and other paperwork contain the correct details for your business.

6.     Register for PAYE and tax

Within two weeks of registering your company with Companies House, you will be sent a letter by HMRC to the registered address of your limited company. This will explain your legal obligations when it comes to both reporting and tax, along with your company’s Unique Taxpayer Reference (UTR).

You’ll need this UTR, along with your Company Registration Number to register your limited company for Corporation Tax. This must be done within three months of beginning trading through your limited company.

If your annual VAT taxable turnover is expected to exceed £85,000, you will also need to register your limited company for VAT. You can also choose to voluntarily register for VAT. Many business owners choose to do this if they find that it may increase the tax efficiency of the business, or the standing of the company.

In order to pay any employees and to pay yourself a director’s salary, you’ll first need to register your business as an employer and to set up PAYE – Pay As You Earn. It’s perfectly possible to operate PAYE in-house through payroll software, but many businesses choose to use a payroll provider for this service.

Related questions

Can I transfer from sole trader to limited company?

If you’re currently operating your business as a sole trader, you might be wondering whether you can transfer your business to a limited company. It’s perfectly possible to do so and you might even find that your business becomes more tax efficient when you become a limited company. The process to do so is relatively straightforward and does not require much time or effort.

Is it more tax efficient to be a limited company?

Some people find that it is more tax efficient to operate their business as a limited company. This is because limited companies are subject to a flat rate of 19% Corporation Tax, in contrast to Income Tax or 20% – 40%. It’s also possible to minimise your personal Income Tax and National Insurance contributions by splitting your income between a salary and dividend payments.

If you’re unsure whether your business will be more tax efficient operating as a limited company, it’s always best to contact a qualified accountant for professional advice.

Is it better to be Ltd or sole trader?

The decision of whether to operate your business as a sole trader or limited company is personal, and there’s no right or wrong answer as to which is better. If you’re unsure of whether to operate as a limited company or a sole trader, we’d always recommend seeking advice from a qualified accountant who can review your accounts and explain the pros and cons of each legal structure for your business, enabling you to make an informed decision.

Is it worth transferring from a sole trader to a limited company?

There are both advantages and disadvantages of operating as a limited company. For some businesses, it’s the ideal option, giving them tax efficiency and limiting the liability of shareholders and directors. However, this isn’t the right choice for every business, so it’s always worth seeking advice from a qualified accountant before making your decision.

The best legal structure for your business will depend on your personal circumstances, the turnover of your business and your individual preferences. Every one of these factors needs to be taken into consideration when choosing the right course of action for your business.

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