How to change your contractor business from sole trader to limited company

When choosing your business structure, there’s no doubt you’ll have done your research and chosen the best one for you, and for many aspiring business people wanting a quick start, this will be as a sole trader.

But, what’s best for you as a start-up may not necessarily still be the best further down the line. Circumstances can change, businesses may grow, and government policy may change, so the way we work may need to adapt to suit our needs, including the need to increase take-home pay.

With those factors in mind, let’s explore why it might benefit you to change your contractor business from sole trader to limited company, writes Christian Hickmott, managing director of Integro Accounting. I will also recommend what criteria to look at to make this transition from sole trader to limited company and of course, how to go about it all.

The differences between a sole trader and a limited company

A sole trader is a self-employed individual running their own business. HMRC will view you and your business as the same entity – any profits your business makes are yours (after you’ve paid the tax owed). Similarly, you are personally liable for any legal disputes and debts or losses that your business makes.

A limited company is a separate legal entity from its owner/s (director/s). And as such, the finances of the company are required to be kept separate. Legal liabilities, debts and losses of the company therefore are also separate to the director. 

Why change from sole trader to limited company?

In our experience, financial reasons play a large part in people choosing to change their business structure in this way.

Sole traders pay personal income tax on their business’ profits. However they need to be mindful of the rate of tax they pay -- if their earnings are increasing, there comes a point that the tax they’re paying could be reduced if they changed to working through their own limited company. Generally speaking (and the following is not definitive nor a one-size-fits-all rule), if the income to your business, less the costs to your business, result in profits that are less than £30,000 then it could be worth staying as a sole trader.

Limited companies on the other hand will owe corporation tax on profits, plus, as a director you’ll pay income tax on the salary you take from the company via payroll. On the surface, it may sound like you’ll be paying more, but the rates could work in your favour and speaking with your accountant for some quick calculations will help you work out whether forming a limited company is worth your while. A pay structure mixed with a minimal salary and the balance in shareholder dividends (this is not an option for sole traders) could mean less tax and National Insurance Contributions owed to HMRC – bearing in mind that dividends can only be paid out to company shareholders once corporation tax has been paid.

Further related to tax, there are some business expenses that you can claim tax relief on as a limited company but not as a sole trader.

By claiming these expenses your profit is reduced and in turn the amount of tax you owe reduces accordingly.

Benefits of being a limited company

Other reasons it may benefit to change to a limited company could be:

  • increased reputation and legitimacy in the eyes of your clients (N.B some businesses simply won’t engage with non-limited company businesses)
  • more credibility to lenders or banks (for borrowing purposes),
  • the ability to get protection from the limited liability that a ‘limited company’ provides you (a 2014 study by HMRC found that this is the main reason to incorporate a business)
  • the ability to ever so slightly safeguard your business name by registering it with Companies House.

How do I change from Sole Trader to Limited?

If you’ve decided to take the plunge, here are the steps you’ll need to follow:

  • Choose a company name

You may wish to choose something that reflects your business activity. Go for something that is simple to spell and pronounce; avoid sensitive words and op for a unique name that’s not already in use on the Companies House register. Use the Companies House name checker here.

  • Register your limited company

Once you have settled on a name it’s time to register your company with Companies House!

This will cost £12 if you do it yourself online, although if there are things you’re unsure about, many accountants offer a ‘same day’ formation service and can do this for you.

Things you need for this are:

  • Your company’s registered office address and your director’s service address. These need to be UK addresses, and will be publicly available on the Companies House register. So if you don’t want to use your home address, it’s worth considering a contractor accountant who offers a registered office address service.
  • A Standard Industrial Classification (SIC) code. You’ll need to select which SIC code is appropriate to the nature of your business activity. To find yours see here.
  • A director and their details. Every limited company needs at least one director aged 16 or over. If you’re to be the company’s owner, this will be you – you’ll be responsible for the running of the company,  as well as filing reports, returns and accounts on time. You’ll need to provide details including full name, address, date of birth and nationality.
  • Share allocation. Consider the total number of shares to be held in your company, whether you’ll be the only shareholder (there must be at least one), or whether you’ll add another – and subsequently how many shares you’ll allocate to them.
  • Notify HMRC

When you stop trading as a sole trader and start trading through a limited company, you will need to tell HMRC that you’re stopping self-employment via their online form. You’ll also need to send them your final personal tax return detailing your sole trader income.

  • Open a business bank account

As the finances of your limited company need to be separate from your own personal finances, any money your business makes belongs to the company and not you personally, so you’ll need to open a business bank account in your company name.

Not only will this give you much better visibility of what’s coming in and out, but your book-keeping should also be more manageable.

  • Obtain relevant business insurance

As a sole trader you may already have business insurance, but this will be in your name – you’ll now need a policy in your company name instead.

  • Consider whether you need to be VAT registered

Once your annual turnover exceeds £85,000, it is a legal requirement that you register for VAT – although you may have already registered voluntarily for other reasons. If you’re already registered for VAT as a sole trader, HMRC requires you to inform them within 30 days of starting your limited company. You can then either request a transfer to your new company, or de-register for VAT and then register your new company.

  • Register for PAYE (Pay As You Earn)

In order to pay yourself as the director, or pay any employees their salary, your company (the employer) will need to be registered for PAYE with HMRC. You can do this online.

  • Register for Corporation Tax

Companies House will automatically inform HMRC of your newly formed company, shortly after you’ll then receive a letter in the post from HMRC containing a Company Unique Taxpayer Reference (UTR). You’ll need this and your company registration number when registering for Corporation Tax, which needs to be done within three months of incorporation.

Final thoughts

Taking into account the above, it really boils down to what’s best for you and your situation as to whether switching from sole trader to limited company is the right move. Making sure you fully understand the advantages and disadvantages before you decide is important, and talking things through with an accountant will give you peace of mind.

Wednesday 28th Sep 2022
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Written by Christian Hickmott

Founder and CEO of Integro Accounting, Christian Hickmott has over 20 years of accountancy and working practice knowledge. He understands the wants and needs of contractors, having lead some of the largest accountancy firms in the business before founding Integro Accounting in 2013. A brand based on integrity, trust and loyalty.

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