When should I transition from sole trader to limited company?

Many new business owners start out as sole traders. With fewer administrative and accounting requirements, it’s easier to get started. However, there are times when switching from a sole trader to a limited company might be beneficial. 

Here are seven signs it could be time to make the change.

1. Your earnings are increasing

As your earnings grow, it might be smart to switch to a limited company to keep more of your hard-earned money. There’s no exact amount you should make before it’s sensible to make the switch, but it usually pays off when the tax savings outweigh the extra costs of running a company.

When you're self-employed - be it as a sole trader or a freelancer, you pay tax on your income through your annual Self Assessment. Depending on how much you earn, you might have to pay Income Tax at the highest rate (45%), and National Insurance as well. You can estimate your Self Assessment tax bill using this online calculator.

On the flip side, limited companies pay Corporation Tax, which is often lower than Income Tax. This is how it looks for the 2024/25 tax year:

• If your profits are under £50,000, you'll pay a Corporation Tax rate of 19%.

• If your profits are over £250,000, you’ll pay 25%. 

• If your profits fall between £50,000 and £250,000, you get a bit of a break with marginal relief, which provides a gradual increase to Corporation Tax rates.

As a company director and shareholder, you have more options to structure your income in a tax-efficient way:

• Small director’s salary: Pay yourself a salary up to the Income Tax or National Insurance Contributions (NIC) threshold.

• Dividends: Take the rest of your income as dividends, which are taxed at lower rates than salary income and are not subject to NIC.

Remember, you'll still pay personal tax on any salary or dividends you take from your limited company via Self Assessment. But with some careful planning, you can minimise the total tax you pay. This approach can lead to significant tax and NIC savings. An accountant will be able to advise you on this in more detail. 

2. You want to limit personal liability 

As a sole trader, you’re personally responsible for all your business’ finances. But with a limited company, the financial risk is shared among the shareholders. 

When you set up a company, you will have to state how many founding shareholders it will have. These shareholders each agree to take at least one company share. After incorporation, you can issue more shares to both existing and new shareholders as needed. This means each shareholder is only liable for the amount they’ve invested, so your personal assets are protected if things go wrong.

3. You’re ready to expand your business 

Being a sole trader can be stressful and overwhelming. When you reach a stage where additional input, perspective or investment is needed, transitioning to a limited company can be beneficial. 

Forming a limited company offers the flexibility to take on directors and sell shares. This structure also makes it easier to plan for succession, ensuring your business can continue even if you step away from it. This flexibility can be crucial for long-term growth and sustainability. 

However, expanding your business as a limited company means more complex management and governance. You’ll need to navigate shareholder agreements and potentially deal with conflicts among directors. So it’s important to make sure you’re ready for these new challenges. 

4. You want to attract investment 

If you need to raise capital, converting to a limited company opens up more investment opportunities. You can issue shares, attract investors and access a wider range of bank loans and grants. Investors are often more willing to invest in a limited company due to its perceived stability and potential for growth. You can find investors through various channels such as crowdfunding, angel investment and peer-to-peer finance. 

Although it’s worth remembering that bringing in investors means you’ll be sharing ownership of your company. You’ll need to manage relationships with shareholders and potentially face pressure to deliver returns on their investment. 

5. You need to protect your business name 

As a sole trader, your business name is not legally protected unless you pay for a trademark or set up a dormant company (i.e. a company that’s not trading). By converting to a limited company, your business name gains automatic legal protection under the Companies Act 2006. 

This law ensures that no other company can register a name that’s identical or too similar to yours, helping to secure your brand identity and prevent misuse. If you’re considering this change, you can easily check the availability of your desired company name with this free name checker. 

6. You want to maximise business expense claims 

Limited companies can claim a broader range of business expenses compared to sole traders, helping to further reduce your tax bill. While sole traders can claim tax relief on expenses like insurance or work-related costs, working from home and professional services such as an accountant - limited companies can also claim for additional costs too, such as formation costs.

Claiming these expenses requires meticulous record-keeping. Any mistakes or over-claims could lead to penalties or tax investigations. You might need professional accounting services to manage these claims accurately, which will add to your business costs. And if you’re unsure what expenses you can claim - contact HMRC directly. 

7. You’re ready to enhance your professional image 

Switching to a limited company can enhance your brand reputation. Seeing ‘Limited’ or ‘Ltd’ in your company name can signal credibility and professionalism. A limited company is subject to strict regulations and must comply with the Companies Act 2006. This transparency can reassure potential clients, suppliers and investors. Your company’s details such as who owns and runs it, the registered office and its financial status are all publicly available, adding to your business’s credibility. 

However, the increased visibility also means any mistakes or delays in filings are on public record, which could harm your reputation if not managed properly. Additionally, maintaining this professional image involves adhering to more rigorous compliance and reporting requirements, which can be time-consuming and costly.

Remember - as a sole trader you can use personal bank accounts and savings accounts to manage finances. If you’re a limited company you cannot do this. A limited company is a separate legal entity and so its finances must be kept separate.

How to switch from sole trader to limited company

Ready to make the switch? Here’s a quick rundown of the steps involved:

• Register your company - You’ll need a government gateway user ID and password for your company.

• Notify HMRC - Inform HMRC that you are no longer self-employed. 

• Transfer business assets - Move any business assets to the new company, which may involve Capital Gains Tax (CGT). Assets can include inventory, machinery or property. 

• Open a business bank account - Keep personal and professional finances separate. This separation simplifies tax returns and budgeting, ensuring clear financial management and enhanced organisation for your business - all of which can be managed with a business bank account. 

• Notify stakeholders - Inform everyone connected to your business about the change in structure including contractors, clients, suppliers and lenders.

• Register for tax and PAYE - Register your company for Corporation Tax within 3 months of setting up. If you hire employees or choose to pay yourself a director’s salary, you'll need to register as an employer and establish a payroll system.

If you have any questions or concerns about the switch, you may want to seek advice from a financial advisor.