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When you start a business, choosing the right business model is a crucial decision. You have two primary options: becoming a sole trader or forming a limited company. To make the best choice, it’s essential to analyse your business activity and consider the advantages and disadvantages of each model. There’s no “one-size-fits-all” answer here. What works well for one person might not be the ideal solution for another. So, it’s important to carefully weigh your options and select the model that aligns best with your unique needs and goals.
Here are some criteria, after analyzing which, you can make a final decision:
- The type of business you run or plan to run
- Your plans for business development and growing
- What level of commercial risk will you be exposed to?
- What administrative support do you have?
- How do you want your customers to perceive you?
However, if you take into account criteria such as the tax burden and financial security between different types of self-employed workers and small business owners in the UK, it is worth thinking about the advantages of switching from a sole trader to a company.
Sole Trader
A sole trader is a self-employed individual (you can also call it a sole proprietorship or private entrepreneur) who is responsible for the running of their own business. The business doesn’t have any legal identity separate from its owner. This means that you are not employed by another company or person and that you do not pay tax through the Revenue and Customs (HMRC) system. A sole trader is a self-employed worker and is the sole owner of their business.
Limited Company
A limited company is a legal entity whose shareholders’ liability is limited. If such an organization becomes insolvent, shareholders are only liable for the shares they own.
This is one of the main advantages of setting up a limited liability company rather than being a sole proprietor.
From a legal point of view, a limited liability company is completely separate from the person or persons forming it. It can consist of one or more owners and several shareholders, as well as participants. It can still be owned by a single owner, similar to how a sole proprietorship operates. Even so, the owner and the business are still treated as separate entities in the eyes of the law.
When should I change from sole trader to limited company?
A sole trader is suitable for private businesses in the early stages of development. Being a sole proprietor is a good way to test your business model, see if it works, and improve it. There are no registration fees and very little admin, and you make all the decisions on your own. You don’t have to consult other directors or shareholders as the enterprise’s members do. But if your business continues to grow and your annual profit starts to increase, it will make more sense to create a limited company.
The main reason for changing is that sole traders pay income tax on their profits, not corporation tax, and he is personally liable for the debts of the business.
Besides, incorporating a legal entity also opens up more ways to finance your business. As a private entrepreneur, you can take out business loans from banks, but you cannot get private financing, like selling shares in your business. You can do one or the other with the firm.
Quickly select a jurisdiction and register your company anywhere in the world online
How to move from sole trader to limited company?
According to the official UK government website, under UK law if you decide to move from a self-employed to a limited company you must notify HMRC (HM Revenue and Customs) that you decide to change the legal structure of your business.
As well as registering under your new structure, you’ll need to inform HMRC if you stop being a self-employed 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 need to send a final tax return.
Next, what you’ll need is a transferring assets from sole trader to limited company. This includes any property, inventory, machinery, and equipment that you own.
Legal basis
For the procedure of changing from sole trader to limited company to be correct, it is necessary to refer to the legislation. In particular, the requirements and criteria for establishing a company are described in the Companies Act 2006.
You can also follow the UK official government website, and find there a guide on how to incorporate a legal entity, find a template of necessary documents and forms that are mandatory to fill.
How long does it take? How much does it cost?
Companies House is an executive body of the government that maintains the company register and is responsible for registering all forms of company in the United Kingdom. Company House makes it easy for you to register your legal entity online or by post.
For private limited companies, you can register your business online for just £12, provided that:
- There is everything you need to set up.
- It is limited to shares.
- It will use a standard article of association.
You will need to fill in form IN01, where you provide director and shareholder details and your legal address. After paying the registration fee by debit card or credit card, your incorporation will be done within 24 hours.
For public or private limited companies, you can register by post. It costs £40. Such registration usually takes 8-10 days. If you wish to register your firm under the expedited procedure, it will cost £100. The service is provided on the day of payment. You will need to pay by invoice made out to Companies House.
All the applicable fees you can find on the official website of Companies House.
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The process of switching from sole trader to company
As was mentioned above a sole trader notifies HMRC about his activity stops and files an annual return. Then several steps to setting up a legal entity should be followed.
Here are the key stages involved in the forming process:
Stage 1. Check the correctness of choosing a business model
Make sure you choose the most suitable structure for your business. You can write down goals, objectives, main types of activities, and a business plan.
Stage 2. Choose your company name
It must follow the requirements of Part 5 of the Companies Act. This Part 5 contains rules regarding prohibited names, sensitive words or expressions, and permitted characters in the company’s name. The name must not make false implications and must not be offensive.
Stage 3. Shareholders Choosing and Appointing the Director
Your firm must have at least one shareholder, who can also be a director. Shares can be divided among the directors. A shareholder with more than 25 percent of the shares is a ‘person of significant control’ (PSC).
Your entity must have at least one director. The director has ultimate responsibility for filing the accounts and paying its corporation tax.
You can also appoint a company secretary, though this isn’t compulsory.
Stage 4. Creation of company documentation
Here are a number of docs you need to set up a legal entity:
- A completed form IN01
This form will ask for details including at least three pieces of information about yourself, shareholders and directors. This information can include:
- Town of birth
- Telephone number
- National Insurance number
- Passport number
- Address / registered limited company address
As a company address, you can use a personal address.
- Articles of Association.
This is a legal document of written rules that outlines the rights and powers of the shareholders and directors. You can opt to use standard articles (also known as model articles), which is the default set of articles established by the Companies Act 2006. Or you can write and upload your own with the help of a legal adviser.
- A Memorandum of Association.
The Memorandum of Association is a legal statement signed by all initial shareholders or guarantors. A Memorandum of Association shows that they agree to form the company. It will include your new limited company name, location, and business type. There are online templates available provided by Companies House. You’ll only need this document if you’re registering by post. If you’re registering online, it will be created automatically for you, as part of your registration.
Once the company has been registered you can’t update the memorandum. The memorandum of association must be delivered to the registrar together with an application for registration of the firm, and a statement of compliance.
The statement of compliance required to be delivered to the registrar is a statement that the requirements of this Act as to registration have been complied with. The registrar may accept the statement of compliance as sufficient evidence of compliance.
Stage 5. Records
You will need to keep records of all significant details about the company, as well as all its accounting records. Records must be kept for at least six years.
Stage 6. Register with Companies House
If you do your registration online you’ll be registered for Corporation Tax at the same time. If you registered by post or through a formation agent, however, you’ll need to register for Corporation Tax separately within three months of starting the business.
What is the difference between a sole trader and a limited company
Sole proprietorships and limited liability companies are the most popular options for people who want to work for themselves, but there are significant differences between the two.
The main difference is that a sole trader is owned and controlled by one person with unlimited personal liability for the business whereas a limited company will have its ownership split into equal shares.
Does a sole trader have limited liability?
Limited liability means that the business owner is only liable for the debts of the business up to the value of their investment. A sole trader has unlimited liability. This means that the trader bears personal responsibility for the debts of the enterprise. This is because a sole trader is their business. When a business is set up as a sole trader, the firm has no legal personality separate from the owner.
If the organization cannot pay its creditors, the sole proprietor is personally liable and his personal assets may be at risk. An individual entrepreneur bears full responsibility for both the success and failure of the business.
Can I be a sole trader and have a limited company?
When someone has been working on a self-employed basis and their business begins to develop, the next step can often be to incorporate and provide their services via a limited company. Once someone begins to work through their firm, they are no longer self-employed, even though they may carry on doing the work in a similar way to the way they have always done.
This means that once you have a limited company, you cannot simply think of your company’s money as your own as you may have done with your business money when you were self-employed. You also cannot simply declare your company’s money on your next personal tax return in the same way you would have declared your self-employed earnings. The money belongs to your organization.
FAQ
What rate of tax do I pay as a sole trader vs. a limited company?
A ‘small’ company will pay the corporation tax at 20% on its profits. How you will be taxed personally is dependent on the level of income that you draw from the company. This income can be structured in a tax-efficient manner. As a sole trader or partnership, you will be taxed on the profits of the business as they fall, not on what you have drawn from the business which is not as flexible in terms of future tax planning.
What happens if I change my mind and decide I don’t want to be a limited company after all?
All you have to do is complete a form to be removed from the register of companies at Companies House.
Can you change from sole trader to limited company? Or can an ltd company back to the sole trader?
Both ways are definitely possible. It is a fairly simple process. Changing from self-employed to limited company and vice versa. A lot of businessmen start out as sole traders and as their business grows, they then move to setting up a limited company. Some also moving back to being sole traders again.
