Many new business owners get started as sole traders. It’s the simplest structure to set up, there are fewer administrative and accounting requirements, and it suits the needs of countless entrepreneurs and freelancers. However, there are certain points at which it may be worthwhile converting from a sole trader to a limited company. In this article, we explore 7 indicators that can suggest it’s time for a change.
1. When you’re earning over a certain amount
To keep more of your profits, a good time to convert from a sole trader to a limited company is when your earnings start to pick up. There isn’t a set amount, but it’s usually when the potential tax savings outweigh the additional costs required to run a company.
Currently, you’d need to be earning at least £30,000-£40,000 per year for it to be worthwhile switching to a limited company for reasons of tax efficiency. In this income range, you’d see tax savings of between £500 – £960 per year before factoring in the additional costs and your allowable business expenses.
The extra costs you’ll incur from running a company (all of which are tax-deductible) are:
- Maintaining a non-residential registered office address – approximately £40 per year
- Annual confirmation statement filing fee – £34 per year
- Accountant’s fees – from around £250 per year to prepare annual accounts or a tax return, or between approximately £50-£250 per month for an all-inclusive bookkeeping and accounting package
You can use your home address as a registered office, which doesn’t cost anything. However, the address details will appear on the public record, so this is not advisable.
Hiring an accountant is also optional but highly recommended. You can use an accountant on a pay-as-you-go basis for things like year-end accounting, tax returns, and payroll services. However, pay-monthly packages that include bookkeeping, accounting, and tax-planning services usually offer better value for money.
Accountancy fees vary widely, depending on the size of the company, the complexity of business activities and finances, and the extent of services provided by the accountant.
Where do the tax savings come from?
Sole traders pay Income Tax on all of their profits above the £12,570 personal allowance (for the 2024/25 tax year). They also pay Class 4 National Insurance contributions (NIC). This means you could be paying as much as 40% Income Tax as a self-employed individual if you earn over £50,270 a year, and 45% tax if you earn over £125,141 a year (Scottish Income Tax rates are higher).
Meanwhile, limited companies pay Corporation Tax instead, and normally at a lower rate than Income Tax. Small companies with annual taxable profits of under £50,000 pay the ‘small profits rate’ of Corporation Tax at 19%. Those generating over £250,000 pay the main rate of 25%.
In addition, companies with annual taxable profits between £50,000 and £250,000 can apply for Marginal Relief. This provides a gradual increase to Corporation Tax rates – an option that’s unavailable to sole traders.
As a company director and shareholder, it’s also possible to structure your personal income from the business in a more tax-efficient way. You can achieve this by:
- paying yourself a small director’s salary – usually up to the point at which you’d be liable to Income Tax and/or National Insurance contributions (NIC)
- taking the rest of your income as dividends – these earnings are taxed at lower rates than salary income and are not subject to NIC
Having the flexibility to pay yourself in this way means you could pay less tax and National Insurance contributions on the same amount of money that you earn as a sole trader.
There is also an annual tax-free dividend allowance, which is £500 from 6th April 2024.
Our blog post on paying yourself through a limited company provides more detailed guidance on how much tax you would pay on a director’s salary and shareholder dividends.
2. When you want to boost your professional reputation
Another indicator that could suggest it’s time to convert from a sole trader to a limited company is when you want to take your brand reputation to the next level.
Operating as a limited company is often perceived as more credible compared to the sole trader model. When people see ‘Limited’ or ‘Ltd’ at the end of your company name, they associate it with security, reliability, and professionalism.
This is because limited companies are regulated by the Companies Act 2006, and their corporate information is available on the public register. Should a customer or investor, for example, want to find out more about your company, they can check details like:
- Who owns and runs the business
- Where your registered office is
- Your company status (e.g. active or dormant)
- Whether you have delivered your accounts and other statutory filings on time
- The nature of your business
- Your annual accounts
This type of information about sole traders is not freely available. Also, where it might be provided, there’s no way for people to know whether it’s accurate.
Being governed by legislation generally makes limited companies more trustworthy than sole traders, which can be highly beneficial for boosting your reputation.
3. When you want to protect your business name
As a sole trader, your business name isn’t legally protected unless you pay for a trade mark or set up a dormant company with your sole trader name. This means that any other business can use the exact same name for its activities. If you want to protect your brand identity, it’s time to convert to a limited company.
Under the Companies Act 2006, no two company names can be the same or similar. This is because it could confuse the public and imply a connection between completely separate entities.
So, when you convert to a limited company, it’ll automatically be protected by the Act (provided that your business name is acceptable and available), preventing other companies from copying or resembling it in any way.
You can check if your business name is available to register with our free company name checker on the Quality Company Formations homepage.
4. When you want to claim more business expenses
Limited companies can claim a broader range of business expenses compared to sole traders. If you want to reduce your tax bill even more, then it could be time to change your business structure.
Sole traders can claim tax relief on the following expenses:
- Office, property, and equipment
- Car, van, and travel
- Clothing (e.g. uniforms)
- Staff expenses
- Reselling goods
- Accountancy, legal, and other professional fees
- Marketing, entertainment, and subscriptions
- Training courses
Meanwhile, limited company owners can claim the following additional expenses:
- Professional costs of setting up your company (e.g. solicitor, accountant, or company formation agent fees)
- Staff events (e.g. Christmas parties)
- Bicycle mileage (for you or your staff)
- Business gifts for staff and clients (restrictions apply)
- Charity donations
- Employee eye tests and glasses
- Director pension contributions
While sole traders are entitled to many types of business expenses, companies qualify for a wider range of tax-deductible expenses and allowances. This means that by converting to a limited company, you can reduce your tax bill further and retain more of your profits.
5. When you want to seek new investment
If you need to raise capital to strengthen your business, it could be time to convert from a sole trader to a limited company.
That’s because a limited company structure considerably opens up your investment opportunities. You can find investors through various avenues (like crowdfunding and peer-to-peer finance), issue new shares, and receive small business grants.
You could even find that you’re eligible for a wider range of bank loans as a limited company owner. Lenders will perceive you as more credible and professional, which can often increase the number of products available to you.
6. When you want to limit your liability
As a sole trader, you’re personally responsible for the entirety of your business finances. However, when you convert to a limited company, your personal liability is reduced.
When you set up a company, you’ll have to state how many subscribers (founding shareholders) it will have. These shareholders each agree to take at least one company share. After incorporation, you can issue more shares to existing and new shareholders if need be.
Later down the line, should the company be unable to repay its debts or face legal action, that financial risk is spread amongst all shareholders. Each shareholder’s liability is limited to the amount paid for their shares (plus any unpaid amount on any nil-paid or partly-paid shares).
By converting from a sole trader to a limited company, you take on a calculated risk that you are comfortable with. If anything goes wrong, you’ll have the peace of mind that your liability is limited and your personal assets are protected.
7. When you want to grow your business
A sole trader business is a one-man band. So, when you want to scale up or bring in business partners, it’s worth forming a limited company. However, you still have the option to run a limited company by yourself as the sole shareholder (owner) and director of the business.
Introduce business partners
The limited company structure will allow you to take on other directors and sell shares in the business, helping you go from strength to strength. This level of flexibility can be incredibly advantageous.
For instance, directors manage the company’s daily operations and complete a range of administrative tasks, while shareholders add financial backing and professional expertise in return for an equity stake.
It’s important to note that you’ll no longer be the sole decision-maker if you bring in new investors and appoint additional directors. You’ll share ownership and certain privileges with your new business partners.
However, being a solo entrepreneur can be stressful and overwhelming. When you get to a stage where you need additional input, perspective, or investment, converting to a limited company can be beneficial. Business partners can help you make important decisions and work toward the goals that will keep your company growing.
Succession planning
As a sole trader, your business will cease to exist when you’re no longer able to run it. Whereas, a limited company is its own legal entity, so it can live on despite changes in ownership or leadership.
This means that you can:
- appoint other directors to run the business on your behalf – for example, if you want to take a step back from day-to-day duties or focus on another venture
- hand over the reins to your children or other successors when it’s time to retire
- sell the business as a going concern
When it comes to planning your own future and that of your business, converting to a limited company offers far more options and greater flexibility than the sole trader structure.
How to change from a sole trader to a limited company
Changing from one business structure to another can be complicated. Generally, you need to follow these steps:
1. Register your company
The easiest way to do this is with the help of a company formation agent. Our expert team here at Quality Company Formations can guide you through the process and have your company registered in just a few hours. To get started, take a look at our formation packages and guide to setting up a company.
2. Tell HMRC that you’re no longer self-employed
You’ll need to notify HMRC that your business structure has changed and you’re no longer operating as a sole trader.
3. Transfer your sole trader business
If you have any business assets (like property, machinery, or inventory), they need to be transferred to your new company. You may incur Capital Gains Tax (CGT) charges here, depending on the assets.
4. Open a business bank account
This isn’t a legal requirement, but we recommend opening a business bank account in your new company’s name to keep your personal and professional finances separate.
5. Notify stakeholders about the new business structure
All stakeholders (including contractors, clients, suppliers, and lenders) must be notified that your legal business structure has changed.
6. Register for tax and PAYE
You need to register your limited company for Corporation Tax within 3 months of starting to trade through this new structure. If you take on employees or decide to pay yourself a director’s salary, you’ll also need to register as an employer and set up payroll.
This is just a summary of the main steps to changing your legal business structure. The process can be complicated, and there are several rules and requirements for each step, so we strongly advise that you seek professional assistance.
Thanks for reading
So, there you have 7 key signs that it might be a good time to change from a sole trader to a limited company. Both structures have pros and cons, so it’s a decision that requires careful consideration based on your personal preferences and the needs of your business.
If you’re still unsure, speak to an accountant for expert advice on whether to continue as a sole trader or set up a company.
We hope you found this guide helpful. If you have any questions about setting up or running a company, leave a comment below or get in touch with our company formation team.
