Setting up as a sole trader is the simplest way to start and run a business in the UK, making it the go-to structure for many self-employed individuals. However, the tax benefits and financial security of a limited company lead many people to consider converting from sole trader to limited company.
In this post, we explain the process involved and the key differences between these two popular business structures. This information should help you decide whether it’s best to continue operating as a sole trader or make the switch to a limited company.
Steps required to convert from sole trader to limited company
There are a number of steps involved in converting an existing small business from a sole trader to a limited company. The complexity of this process depends on a variety of factors, including the transfer of business assets, the third parties you need to notify, and the extent of administrative updates you have to carry out.
We recommend seeking professional advice and guidance from an accountant on the tax implications of making this change.
1. Register a limited company
The first step is to register a company limited by shares. The easiest way to set up a company is through an approved company formation agent like 1st Formations.
It is an incredibly straightforward process that you can carry out entirely online, with most applications approved by Companies House (the UK registrar of companies) within 24 hours.
To register a limited company online, you will need:
- a unique company name
- a registered office address
- at least one Standard Industrial Classification (SIC) code to describe the nature of your business activities
- at least one director and one shareholder
- details of every person with significant control (PSC)
- articles of association
The same person can be both a director and a shareholder. Therefore, you can set up a company on your own by naming yourself as the sole director and shareholder. In this situation, you would also be the only person with significant control (PSC) in the company. Consequently, you would have full ownership and control of the business, just as you do as a sole trader.
- How to register a company in 4 simple steps with 1st Formations
- Directors, shareholders, PSCs, and company secretaries – an overview
- Guidelines for creating a limited company name
Limited company names are subject to more rules and restrictions than sole trader names, so you must adhere to strict guidelines. If you wish to register your existing sole trader name as a company name, use the company name checker on our homepage to find out if it is available before you begin the application process.
Our company formation checklist provides a detailed overview of the Information required to set up a company.
2. Tell HMRC that you have decided to stop being a sole trader
When your company is set up and you’re ready to start trading through this new business structure, you must tell HMRC that you are stopping self-employment and will cease running your business as a sole trader.
To do this, you will need to sign in to your HMRC account and provide the following details on the ‘Stopping self-employment’ online form:
- the date on which you stopped being self-employed
- your Unique Taxpayer Reference (UTR)
- National Insurance number
- name and date of birth
- current address and previous address
- nature of trade (your sole trader business activities)
You will also need to send a final Self Assessment tax return as a sole trader. The income that you report on the return should include your self-employed earnings and tax liability up to the date on which you stopped being a sole trader. You may also have to include:
- allowable expenses, including any costs involved in converting your business structure
- capital allowances on any sole trader assets transferred to your limited company
- Capital Gains Tax (CGT) on any business assets transferred to the company
You must ensure that you file your final tax return, and pay any tax that you owe, by the usual deadline of 31 January after the end of the tax year to which the return relates.
3. Transfer your sole trader business to the new company
Depending on the nature of your sole trader business, you may have to transfer your existing business assets (such as property, machinery, equipment, inventory, etc) to your limited company.
Since the company is new, it is unlikely to have available funds to pay for these assets. In this situation, the most common approach is to create a director’s loan account, whereby the company pays you (the director) over time for the transferred business assets.
Transferring certain assets may trigger Capital Gains Tax (CGT) liability. This will be based on the current market value of the assets at the time of transfer.
However, depending on your specific circumstances, you may be able to reduce or defer CGT by claiming some form of tax relief, such as Incorporation Relief, Business Asset Disposal Relief (formerly Entrepreneurs’ Relief), or Gift Hold-Over Relief.
Transferring assets can be a complex matter for some businesses, so we advise speaking to an accountant for expert help and advice.
4. Set up a business bank account in your company name
There is no legal requirement for sole traders or limited companies to operate business bank accounts. However, it is best to keep business and personal finances entirely separate at all times.
This is particularly important when you’re running a limited company because all business income legally belongs to the company until it is transferred to you as a salary, dividend payment, reimbursement of expenses, or director’s loan.
Aside from minimising the risk of accidentally spending company funds on personal expenses, operating a business bank account makes it easier to maintain accurate bookkeeping and accounting records.
At 1st Formations, we have partnered with several leading names in UK banking to offer our customers an excellent selection of business bank accounts, including Barclays, NatWest, Tide, ANNA, Monzo, and Zempler. These accounts are available to customers during the online company formation process.
5. Notify all stakeholders about the change of business structure
Regardless of whether you register a new company name or keep your existing business name, you will have to tell certain parties that you are changing the legal structure of your business from sole trader to limited company.
The various stakeholders that you may have to notify include:
- employees and contractors
- customers and clients
- suppliers and service providers
- banks, lenders, and other finance providers
- landlords
- debtors
This minimises any risk of confusion or voiding of contractual agreements and ensures that all paperwork and invoices contain the correct details.
You will also have to update your own business stationery and website with your full company name, registered office address, and company registration number.
6. Register your limited company for tax and PAYE
When you incorporate your new company, Companies House will inform HMRC. You will then receive a letter from HMRC, which will contain your 10-digit company Unique Taxpayer Reference (UTR) and information about your tax and reporting obligations. This will be delivered to your registered office address, usually within two weeks of company formation.
You must register for Corporation Tax online within three months of starting to trade through your new company. Thereafter, you will be required to prepare a Company Tax Return each year and pay Corporation Tax on your company profits.
- An introduction to Corporation Tax
- Do I need to file a Company Tax Return?
- A guide to PAYE registration for company owners
If you expect your VAT taxable turnover to be more than £90,000 within a 12-month period, you must also register the company for VAT. If your sole trader business is already registered for VAT, you may be able to transfer your existing VAT registration to the company. Voluntary VAT registration is also an option.
To receive a director’s salary and pay your employees (if you have any), you will need to register the company as an employer and set up PAYE (Pay As You Earn) before the first payday. You can choose to operate PAYE yourself using payroll software, or you can appoint a payroll provider to take care of this for you.
Sole Trader vs Limited Company: the key differences
A sole trader business is owned and controlled by one self-employed individual. There is no legal distinction between you and the business – you are one and the same in the eyes of the law.
This is hugely significant because it means that, as a sole trader, you have unlimited personal liability for any and all business debts, losses, and legal claims.
Consequently, your personal finances and assets, including your home and savings, are at risk if you are unable to pay business-related debts or you’re sued during the course of running your business. In a worst-case scenario, this could result in personal bankruptcy.
- What is a company limited by shares?
- Limited liability: what does this mean for you and your company?
- Am I self-employed or employed – if I have a limited company?
A limited company is owned by one or more shareholders and managed by one or more directors. The same person can be a shareholder and a director, so you have the option to own and control the business by yourself (just like you do as a sole trader) or jointly with other people.
A limited company has its own legal identity and is liable for its own debts, losses, and any claims brought against the business. This means that the finances, liabilities, and actions of the company are completely separate from those of its shareholder(s) and director(s).
As a result, company owners enjoy limited liability. Beyond what they invest in the company or agree to contribute, their personal finances and assets are protected if the business can’t pay its bills or if it is sued. This is one of the biggest benefits of setting up a company.
Before you convert your business from sole trader to limited company, it’s essential to understand the key differences, as well as the advantages and disadvantages of both structures. We’ve set out all of these in detail in the comparison tables below.
1. Registration requirements and internal business structure
| Sole Trader | Limited company |
| Registered through HMRC | Registered (incorporated) at Companies House |
| No cost to register a sole trader business | Small incorporation fee payable to Companies House |
| You can trade using your own name or another name. There is no need to register this name. | A unique company name must be registered at Companies House during the incorporation process
Stricter rules and requirements apply to company names |
| No legal distinction between the owner and the business – you are the business, and the business is you | A company is a distinct legal ‘person’ that is separate from its owner(s) |
| Unlimited liability – you are held personally responsible for business debts and legal disputes
If your business fails, you are at risk of personal bankruptcy |
Limited liability – the company itself is held responsible for business debts and legal disputes (limited exceptions apply)
If the business fails, the company is at risk of insolvency (i.e. corporate ‘bankruptcy’), not the shareholder(s) or director(s) |
| Owned by one person only | Can be owned by one or more people, who are known as ‘members’ or ‘shareholders’
Managed by one or more people, who are known as ‘directors’ Shareholders and directors can be the same people |
| You are self-employed | You are employed by the company as a director, which means that you may be eligible for certain employee benefits |
| Must provide HMRC with a business contact address. This is not available to the public unless you include it on business stationery or other forms of communication or marketing material | The company must have a registered office address in the country of incorporation
Every director and shareholder must provide a service (‘correspondence’) address Both of these addresses are a matter of public record |
| If a sole trader dies, the business ceases to exist | If the sole shareholder and director of a company dies, the company still exists in its own right. This is known as ‘perpetual succession’ |
| As a rule, certain industries and agencies will not work with self-employed freelancers or sole traders | Depending on the industry in which you operate, you may find that having limited liability protection offers a greater choice of clients and contracts |
2. Business income and taxation (2024/25)
| Sole Trader | Limited company |
| All business income belongs to you | Business income belongs to the company until it is transferred to you as:
• a director’s salary • expenses • shareholder dividends • a director’s loan |
| You pay Income Tax between 20% and 45% (depending on your tax band) and Class 4 National Insurance contributions (NIC) through Self Assessment on all declared business profits above your tax-free Personal Allowance (PA)
If you are a Scottish taxpayer, you pay Income Tax at rates between 19% and 48% (depending on your tax band), as well as Class 4 NIC
|
You pay Income Tax and Class 1 NIC through PAYE on your director’s salary (above your PA)
You pay dividend tax (8.75% – 39.35%) through Self Assessment on dividend income above your PA and the £500 tax-free dividend allowance. These tax rates are lower than Income Tax rates The company pays Corporation Tax (19% – 25%) on all taxable profits You can minimise your personal tax and NIC liabilities by taking a lower salary and higher dividends |
| You cannot pay a spouse or partner through the business unless it is commercially justified (i.e. you hire them as an employee) | If your spouse or partner is a basic-rate taxpayer or not in receipt of any income, you could reduce your household tax burden by making your spouse or partner a shareholder |
| The deadline for paying your Income Tax and NIC liabilities on your sole trader income is almost 10 months after the end of the tax year | Income Tax and NIC are deducted from your salary through PAYE before you are paid
However, you do not have to pay tax on your dividend income until almost 10 months after the end of the tax year |
| You cannot keep profits in the business in order to defer tax until a future tax year. All income is liable to tax in the year it is earned | You can defer tax on profits by leaving surplus income in the company to withdraw in a future tax year
This is a great option if withdrawing all profits in one year would result in your paying a higher rate of personal tax |
| Your ability to borrow capital for business purposes is based on your personal credit rating
You are personally liable for business loans. Therefore, your own credit rating will be impacted if you default on a business loan or are unable to pay it back |
A company can establish its own credit profile and borrow capital in its own name
The company will be liable for business loans taken out in its name. Therefore, it is the company’s credit profile that will be adversely affected if it defaults on a business loan or fails to pay it back |
3. Accounting, reporting, and record-keeping requirements
| Sole trader | Limited company |
| No information about you or your business is made available to the public by HMRC | Company information is a matter of public record, including accounts and information on directors and shareholders |
| No annual filing or maintenance fees | You must send a confirmation statement to Companies House every year to verify the company’s registered details. This costs £34 |
| No legal requirement to keep or submit accounts, though it is beneficial to do so | It is a legal requirement to prepare annual accounts for Companies House and HMRC |
| Must register for Self Assessment
Must report your self-employed income by sending a Self Assessment tax return to HMRC every year |
The company must register as an employer and set up PAYE, even if you (the director) are the only employee
The company must operate payroll to pay, record, and report your director’s salary A Company Tax Return must be delivered to HMRC each year If you are a shareholder as well as a director, you need to register for Self Assessment and send a personal tax return to HMRC every year. The purpose of this is to report your total annual income and tax liability from all sources (salary, dividends, expenses, and any other earnings) |
| Keep records of all sales and expenses | Keep accounting records and company records, including a number of statutory registers that must be made available for public inspection |
4. Expenses and benefits
| Sole trader | Limited company |
| Not eligible for Statutory Sick Pay (SSP) | Company directors may be able to claim Statutory Sick Pay (SSP) |
| Only eligible for a personal pension scheme | Access to more favourable, tax-efficient, and customisable pension scheme options through a company |
| You can claim capital allowances on your car, but you must disallow a proportion for the private use of the vehicle | Companies are eligible for full capital allowances on cars, regardless of any private use |
| Tax relief on mobile phones and computers will be apportioned according to business and private use – an add-back of capital allowances will apply | Mobile phones and computers are tax-free if they are purchased by the company
More tax-free benefits available through a company, including parking charges, public transport, travel costs, health checks, eye tests and prescription eyewear, childcare, and school fees |
| You can’t charge yourself rent for the use of your home for business purposes | You can charge rent to the company for the use of your home for business purposes. This may enable you to offset a proportion of your mortgage interest and council tax |
Sole Trader vs Limited Company: take-home pay comparison
Compared to the sole trader structure, a limited company is usually more tax-efficient and could provide you with a higher take-home pay, depending on how you structure your remuneration.
Below are two simple examples to show how much tax you would pay, based on a trading income of £50,000 for the current 2024/25 tax year.
Sole trader
You are a basic-rate taxpayer and you have an annual tax-free Personal Allowance of £12,570. You won’t pay any Income Tax on the first £12,570 of earnings for the year. Above this amount, you will pay:
- 20% Income Tax* on the remaining £37,430 of earnings = £7,486
- 6% Class 4 National Insurance contributions on profits above £12,570 = £2,245
Your total deductions for the year are £9,731, and your total take-home pay is £40,269
*If you are a Scottish taxpayer, your Income Tax liability will be slightly higher.
Limited company
You can choose to pay yourself a combination of a director’s salary and shareholder dividends. This is the most tax-efficient remuneration strategy for a company director and shareholder.
You have an annual tax-free Personal Allowance of £12,570. Therefore, if you take a director’s salary of £9,100 (the NIC Secondary Threshold, when employer’s National Insurance liability kicks in), you won’t have to pay any Income Tax, Class 1 employee NIC, or Class 1 employer’s NIC on your salary.
The remaining £40,900 of profit will be liable to Corporation Tax of 19% (the ‘small profits rate’), so the company will pay £7,771 Corporation Tax.
That leaves £33,129 profit to take as dividends, which will be taxed as follows:
- £500 Dividend Allowance @ 0%
- £3,470 of remaining Personal Allowance @ 0%
- £29,159 dividend income taxed @ 8.75% (the basic rate) = £2,551
The total deductions on this income for the year are £10,322, and your total take-home pay is £39,678
By trading through a limited company, a tax saving of £591 can be achieved on a £50,000 trading income. That’s without factoring in any tax-deductible business costs and expenses, which will provide additional savings.
How much does it cost to set up and maintain a limited company?
Companies House charges a small incorporation fee to set up a limited company. At 1st Formations, we offer a range of company formation packages from just £52.99, which includes:
- the Companies House incorporation fee
- a ready-to-trade limited company incorporated at Companies House within 3 to 6 business hours (subject to the registrar’s workload on the day)
- expert help and guidance throughout the company formation process and beyond
- all company registration documents, including a certificate of incorporation, share certificates, a memorandum of association, and articles of association
- statutory company registers, which are legally required
- a free business bank account
- additional services, including a London registered office, service address and business address, VAT and PAYE registrations, a Confirmation Statement Service, and much more, can be found in our All Inclusive Package at the discounted price of £149.99.
The only statutory cost of maintaining a limited company is £34/year, which you must pay when you file an annual confirmation statement at Companies House.
You will also need to file annual accounts at Companies House 21 months after company formation, and then every 12 months thereafter. For HMRC, you must prepare a Company Tax Return and accounts every year.
- Convert to a limited company today - with our All Inclusive Package
- What are the filing requirements of a limited company?
- The difference between accounts for Companies House and accounts for HMRC
Whilst there are no filing fees to pay, you may wish to use an accountant to handle your company tax affairs. This would be particularly beneficial if you do not have sufficient bookkeeping and accounting experience or your business finances are complex.
The typical cost of using an accountant ranges from £750 to £1,500 a year for the preparation of accounts and tax returns. This may seem like a significant sum, but it’s a small price to pay for financial peace of mind.
Is it worthwhile converting from sole trader to limited company?
There are some great benefits to setting up a limited company, which we’ve highlighted above, making it a worthwhile decision for many people. However, it is not a one-size-fits-all structure, nor is there a set point at which converting to a limited company is a necessity.
More often than not, changing from sole trader to limited company is simply a matter of personal preference. Ask yourself the following questions to decide if it’s right for you:
- Will I pay less tax and receive a higher take-home pay through a limited company?
- Will the prestige of a limited company help me to attract more clients and grow my business?
- Would I benefit from limited liability protection if my business were to fail?
- Do I want to bring in business partners or attract investment at some point?
- Are these benefits worth the extra administration and filing requirements and potentially higher accounting fees?
Your choice of business structure very much depends on your circumstances and what you are comfortable with. If you are unsure about the best course of action, you should consult an accountant for expert guidance and tailored advice.
Thanks for reading
When deciding whether to change from sole trader to limited company, there is a great deal to consider. We hope that this post has highlighted the pros and cons of both business structures and helped you determine which one is best for your particular circumstances.
Should you have any questions or need help setting up a company, please comment below or contact our company formation team today.
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