Changing from sole trader or partnership to a Limited Company?
Whether and how to switch to Limited Company status – the pros and cons
Running a business as a sole trader or partnership offers flexibility and simplicity, making it an excellent starting point for many entrepreneurs. But, as your business grows, you might face challenges such as higher taxes, personal liability risks, or the need to project a more professional image.
Switching to a limited company can solve these issues, offering tax efficiency, limited liability, and a distinct business identity. But is incorporation the right move for you? In this guide, we’ll explore the benefits, drawbacks, and key steps involved in changing your business structure.
Why incorporate into a Limited Company?
Incorporating your business comes with a range of advantages that can help you save money, reduce risk, and improve your business’s reputation.
Financial benefits of incorporation
Lower tax rates
Limited companies pay corporation tax at 19%, which is often lower than the income tax rates for sole traders, currently set at 20%, 40%, or 45%.
National Insurance savings
As a sole trader, you pay Class 4 National Insurance on your profits. In a limited company, profits paid as dividends don’t incur National Insurance contributions.
Tax planning opportunities
By managing your salary and dividends, you can optimise your tax efficiency. For example, you might allocate shares to family members in lower tax brackets to maximise allowances.
Business benefits
Limited liability
Unlike sole traders or partners, your personal assets are protected from business debts, as a limited company is a separate legal entity.
Professional image
Being a limited company can enhance your credibility with clients, suppliers, and lenders, making your business appear more established.
Name protection and succession planning
Registering your business as a limited company protects its name and simplifies passing ownership to family members or partners.
Why incorporation might not be a good thing for your company
Incorporation isn’t always the right choice for everyone. Here are some reasons you might decide to remain a sole trader or partnership -
Costs of incorporation
Operating as a limited company comes with added expenses. You’ll need to file statutory accounts, prepare annual returns, and potentially hire an accountant—costs that may outweigh the tax benefits if your earnings are relatively low.
Increased administrative responsibilities
Incorporation requires more paperwork and ongoing compliance. You’ll need to manage bookkeeping, file reports with Companies House, and handle corporation tax filings. This added workload might not be worth it if you prefer to focus on running your business.
Suitability for small businesses
If your business profits are modest and you’re not seeking significant growth, staying as a sole trader or partnership might be simpler and more cost-effective. For some, the flexibility of self-employment outweighs the advantages of limited liability.
What are the key steps to incorporation?
Switching from a sole trader or partnership to a limited company involves several steps. Here’s what you need to do to ensure a smooth transition -
1. Decide on a structure
Determine whether you’ll be the sole director and shareholder or bring in others to share responsibilities and ownership.
2. Inform HMRC
Notify HM Revenue and Customs about the change in your business’s legal structure. This is essential to ensure accurate tax records and compliance.
3. Register with Companies House
Choose a company name and submit your registration documents, including a memorandum and articles of association. Once approved, your company will officially be listed as a limited company.
4. Set up a business bank account
Open a dedicated bank account for your limited company to separate business finances from personal funds.
5. Update stakeholders
Inform customers, suppliers, lenders, and insurers about your new structure. If you have employees, notify them about the change and any impact it may have on their contracts.
6. Handle VAT registration
If your sole trader business was VAT-registered, cancel your registration and re-register under the limited company within 30 days.
7. Register for PAYE
To pay yourself and any employees a salary, you’ll need to set up PAYE (Pay As You Earn) with HMRC.
8. Review property and assets
If your business involves property, consult with lenders about transferring ownership. You’ll need to value assets at market rate and adequately account for them in the transition.
9. Update contracts
Revise any supplier or customer agreements to reflect the new company status.
Tax implications of incorporation
Switching to a limited company has several tax implications, which can make the process more complex.
Income tax
You’ll need to prepare final accounts for your sole trader or partnership business, following HMRC’s closing year rules. Overlap profits may apply.Capital Gains Tax (CGT)
The transfer of assets like property or goodwill is considered a disposal, potentially triggering CGT. Incorporation relief may allow you to defer this tax.VAT
If your business is VAT-registered, transferring it as a going concern (TOGC) may exempt the transfer from VAT.Stamp Duty Land Tax (SDLT)
Transferring land or property to the company could result in SDLT liabilities, even if no cash changes hands.
Tax reliefs for incorporation
To minimise tax liabilities during incorporation, you may qualify for certain reliefs. Let’s look at these -
1. Incorporation relief (s.162)
If all business assets (except cash) are transferred to the company in exchange for shares, CGT can be deferred until the shares are sold.
2. Gift or holdover relief (s.165)
If you gift certain assets to the company, you can defer CGT on those assets - particularly useful if you want to retain personal ownership of some assets.
3. Business Asset Disposal Relief (BADR)
This reduces CGT to 10% on gains from the sale of business assets, up to a lifetime allowance of £1 million.
Ready to incorporate? It’s a big decision - we’ll help
Switching from a sole trader or partnership to a limited company can provide significant benefits, including lower tax rates, limited liability, and enhanced business credibility.
However, it’s essential to consider the additional costs, administrative responsibilities, and potential tax implications before making the change.
Incorporation isn’t a one-size-fits-all solution. Your decision should be based on your business’s unique circumstances, including its size, profit levels, and growth ambitions.
The rewards of incorporation are often worthwhile. At Liondaris & Co, we specialise in helping with company formation. From assessing your tax position to handling paperwork and compliance, we’ll take care of the details so you can focus on growing your business.