What Happens When Changing From a Sole Trader to Limited Company?

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July 13th 2020
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What Happens When Changing From a Sole Trader to Limited Company?

Learn when the best time is to become a Limited Company and the associated benefits and requirements.

It is generally thought that as long as your earnings are low and you don't have liabilities that you would preferable be personally shielded from, then the easier administration of operating a business as a sole trader is the correct path. Particularly so when first starting a trade. However, there are scenarios where the need to incorporate outstrips the benefits of remaining a sole trader.

What are the advantages of Limited Companies?

There are many pros of being incorporated, including:

  • Limited Liability - you are personally shielded from the company debts, unless there is a breach of law and as director you are suspected of foul play. Debts the company incurs as well as assets all belong to the company entity.

  • Companies appear to have a rather more professional image, particularly due to the administrative transparency they bring. Trading partners can look up company information and financial information online via Companies House and third parties as part of their due diligence. This is information unavailable to them if they were trading with a sole trader.
  • A bonus to being financially transparent and an entity in its own right is the ability for a company to acquire its own credit rating - and is unaffected by the credit profile of its director(s). It can then grow exponentially as capital borrowing is possible.
  • A company can raise investment by issuing share capital.
  • Profits within a company can be structured in any legal tax-efficient manner. The main tax a company has to worry about (apart from payroll taxes for employees) is corporation tax on profits. Corporation taxes themselves can be reduced by using the multitude of allowable business expenses, tax reliefs and more.

What do you need to do to become a Limited Company?

Get ready for paperwork! Firstly you need to register a limited company. This process is called incorporating and can actually be done faily quickly online directly with the government. Currently fit costs £12 and requires information about the directors, shareholders and guarantors.

The director or directors will be responsible for the actions of the company, but as long as there is no misconduct will be protected within the rules of limited liability. They will also be responsible for tax and non-tax related reporting such as the:

  • Confirmation statement- Formerly known as the annual return. You must keep details help on the company register up to date, so the confirmation statement is filed once per year. It can be done online and allows updating the office address, records address, people with significant control, shareholder and capital information, and SIC codes.
  • The register of people with significant control is a list of people who can influence/control the company - or have a more than 25% shareholding.
  • Annual accounts - The statutory accounts are sent to both Companies House and to HMRC. They should provide a balance sheet, profit and loss account, auditors report and director's report. Small or very small companies can file fewer items from that list.
  • Small companies (any two of: ≤ £10.2M turnover, ≤ £5.1M balance sheet, ≤ 50 employees) do not have to have accounts audited and can send abridged accounts with simpler balance sheet and profit and loss.
  • Micro-entities (any two of: ≤ £632,000 turnover, ≤ £316,000 balance sheet, ≤ 10 employees) do not have to have accounts audited and can send abridged accounts with just a simple balance sheet.

The company needs to be reporting for tax so the service offered online also sets up the corporation tax registration and can set up the PAYE service too (if you are going to have employees).

As we talked about, a limited company is a separate entity in and of itself, so it needs its own bank account to help manage this separation from your personal finances. So, the next step would be to open a business bank account in the name of the business.

If you have assets (in your sole trader business) that are now going to be required by the limited company, you should 'sell' the assets to the limited company. The company should have a directors' loan account (a ledger) to record this transaction so that it can pay you back - tax free. When considering the price at which to sell the assets to the company, remember that you could personally incur capital gains taxes.

You can also de-register as self employed with HMRC at this point.

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