Changing from a sole trader to a limited company

What are the main differences between a sole trader and a limited company? Alex Till, Chief Executive of MENTA, explains how to change from a sole trader to a limited company.

Sole Trader to Limited Company

What is a sole trader?

If you’re a sole trader, you run your own business as an individual and are self-employed.

You can keep all your business’s profits after you’ve paid tax on them. You’re personally responsible for any losses your business makes. You must also follow certain rules on running and naming your business.

It’s simple to set up as a sole trader, but one thing to note is that you’re personally responsible for your business’s debts and you also have some accounting responsibilities.

What is a limited company?

A limited company is a form of business which is legally separate from its owners, also known as ‘shareholders’. There must be at least one company director who is responsible for running the company.

In the UK, the company must be registered at Companies House.

If you form a limited company, its finances are separate from your personal finances, but there are more reporting and management responsibilities.

What are the main differences between Sole traders and Limited Companies?

1) Registration

Sole trader

To set up as a sole trader, you need to tell HMRC that you’re paying tax through Self Assessment. You need to do this if you’ve earned more than £1,000 from self-employment within the tax year. You’ll also need to file a tax return every year.

Limited company

To register a limited company, there are several steps you need to follow:

1. Choose a name - No two limited companies can have the same name, so you’ll have to come up with an original name for your business.

2. Choose the directors and company secretary - Every limited company needs at least one director (someone responsible for running the company), but they can have more. 

3. Decide on your shareholders - A limited company needs at least one shareholder. Shareholders can also be directors. As a small business this might mean you only have one shareholder, and you own 100 per cent of the company.

4. Prepare a memorandum and articles of association - These are the documents that say how you’re going to run your limited company.

  • The memorandum of association is the legal document that all your initial shareholders sign, agreeing to form the company. It’s created automatically when registering your company online.
  • The articles of association are written rules about running the company, agreed on by the directors and shareholders.

5. Keep accurate records - There are two types of records you need to keep:

  • records about the company
  • financial and accounting records

6. Register with Companies House - You can register via the Companies House website or through a variety of incorporation websites.

2) Tax

As a sole trader, you need to pay National Insurance and submit a personal Self Assessment tax return to HMRC at the end of each tax year.

Instead of paying Income Tax and National Insurance, limited companies pay Corporation Tax on their profits.

3) Accounting

Sole Trader

  • pays tax on business net profit
  • required to submit an annual Self Assessment tax return.
  • might be required to register for VAT and submit VAT returns (if turnover is more £85,000 a year)

Limited Company          

  • company accounts submitted to Companies House annually
  • Corporation Tax return submitted to HMRC
  • director’s payroll might also require PAYE
  • directors also register for Self Assessment and submit annual Self Assessment tax returns

4) Expenses

Sole trader - If you’re self-employed, your business will have various running costs. You can deduct some of these costs to work out your taxable profit if they’re allowable expenses. These include:

  • office costs, for example phone bills
  • travel costs, for example fuel or parking
  • clothing expenses, for example uniforms
  • staff costs
  • things you buy to sell on
  • financial costs, for example Insurance or bank charges
  • costs of your business premises
  • advertising or marketing
  • training courses related to your business

Limited Company - You can deduct any business costs from your profits before tax. You must report any item you make personal use of as a company benefit.

How much does it cost to set up a limited company?

It costs £12 online and can be paid by debit or with credit card or PayPal account. Your company is usually registered within 24 hours. Postal applications take 8 to 10 days and cost £40 (paid by cheque made out to ‘Companies House’).

How do I change from a sole trader to a limited company?

Most people start out as a sole trader and then form a limited company when they have a good customer base and a steady income.

The process of changing from a sole trader to a limited company is relatively simple. Just follow the normal process for setting up a limited company and make sure you tell: 

  • HMRC: You’ll need to contact HMRC to de-register as self-employed and inform them of the change to your company structure.
  • Your accountant: It’s important to tell your accountant that you’re changing to a limited company so they can adjust any tax calculations.
  • Your insurance provider: If you’re changing from a limited company to a sole trader, you might need to review your insurance policy.

About the author

Alex Till is the Chief Executive of MENTA, a leading provider of support for businesses of all shapes and sizes who have provided business advice and support to over 35,000 businesses taking them through their journey of knowledge to the point of establishing their business and securing funding for start-up costs and working capital.

See also

What are Gazette company profiles?

What are the responsibilities and duties of a company director?

How to apply for a Start Up Loan for your business

How do you restore a dissolved company?

A guide to memorandum and articles of association

Find out more

Set up as a sole trader (GOV.UK)

Register your company (GOV.UK)

Self Assessment tax returns (GOV.UK)

Set up a limited company: step by step (GOV.UK)

Image: Getty Images

Publication date: 19 August 2021

Any opinion expressed in this article is that of the author and the author alone, and does not necessarily represent that of The Gazette.