• Swindon & Wiltshire Experts
• Wednesday September 4 2024
• Author Name: Amanda Sheppard

From sole trader to limited company: scaling up a business – SWIG Finance

Embarking on the journey from a sole trader to a limited company is a significant milestone for many business owners. The transition not only marks the growth of your business but also involves careful consideration of legal, financial, and operational changes. Amanda Sheppard, business manager at SWIG Finance, takes a deep dive into the steps you need to take to make a successful transition from a sole trader to a limited business.

What is a sole trader?

A sole trader is an individual who owns and runs a business as a single entity. It’s the simplest form of business structure, where the owner is entitled to all profits after tax but is also responsible for all losses and debts. As a sole trader, you’re considered self-employed, making it a straightforward way to start and operate a business, especially in the early stages.

What is a limited company?

A limited company, on the other hand, is a business structure where the company is a separate legal entity from its owners. Shareholders own the company, and directors run it. Unlike sole traders, a limited company’s finances are distinct from the personal finances of the individuals running it. This separation provides financial protection, known as ‘limited liability,’ meaning personal assets are generally not at risk if the company faces financial difficulties.

However, it is important to note, that with a limited personal liability for the business owners, comes a greater risk for those providing credit or other contractual terms to the business (i.e. lenders, premises landlords and suppliers), and as a result it is a common requirement for company directors and shareholders to provide Personal Guarantees in these instances.

Sole trader vs limited company

The key differences between sole traders and limited companies revolve around financial liability, taxation, and the perception of the business. Limited companies tend to have a more professional image, which can be beneficial for winning contracts. The separation of personal and business finances offers a layer of financial protection for the company’s directors. However, limited companies face more rigorous regulatory and reporting requirements than sole traders.

Steps to transition from a sole trader to a limited company:

Register a company:
To transform your business into a limited company, the first step is to register it with Companies House, the UK’s registrar of companies. This process, also known as ‘incorporation’, requires you to select a unique company name that complies with certain naming rules and is not similar to any existing company’s name. You must provide a registered office address within the UK, which will be publicly available and where all official communications will be sent.

During registration, you’ll need to appoint at least one director (who manages the company) and one shareholder (who owns the company). Although they can be the same person in small companies, their responsibilities and potential liabilities differ. The registration also involves a fee, currently set at £12 for online applications.

You are required to submit two crucial documents: the ‘Memorandum of Association’, a legal statement signed by all initial shareholders agreeing to form the company, and the ‘Articles of Association’, which outline the rules for the company’s governance. These documents form the constitution of your limited company.

Set up a new bank account:
Establishing a separate bank account for your limited company is not only a legal requirement but also a prudent financial practice. This demarcation ensures that personal finances are distinct from company finances, safeguarding personal assets from any business liabilities. Additionally, a dedicated business account enhances credibility with clients and suppliers and simplifies accounting and tax processes.

Notify HMRC:
The transition from sole trader to limited company necessitates communicating with HM Revenue & Customs (HMRC). You must inform HMRC of your cessation of self-employment by filling out a “Stopping self-employment” form. This step is crucial to end your self-assessment tax returns under your sole trader status. Depending on the timing, you may also need to submit a final Self-Assessment tax return covering the last period of your sole trading.

Furthermore, you’ll need to register your new company with HMRC for Corporation Tax within three months of starting business activities. This involves obtaining a new Unique Taxpayer Reference (UTR), distinct from the one used for your sole trader activities.

Transfer business assets:
If your sole trader business owns assets (equipment, vehicles, intellectual property, etc.), these need to be formally transferred to your limited company. This process might necessitate legal agreements, especially for significant assets, to document the transfer effectively. It’s also important to consider the tax implications, such as Capital Gains Tax, which may arise from transferring assets at market value.

Consider hiring an accountant:
Navigating the transition and ongoing compliance requirements can be complex. Engaging a chartered accountant or a certified financial advisor can provide peace of mind and allow you to focus on growing your business. They can offer strategic advice on financial planning, tax efficiency, and compliance with corporate governance, ensuring that your company’s financial health is optimally managed.

Setup corporation tax and PAYE:
Upon incorporation, your limited company becomes subject to Corporation Tax on its profits. You’ll use the UTR provided by HMRC post-registration to enrol for Corporation Tax. It’s vital to maintain accurate and up-to-date records to calculate and pay the correct amount of tax.

If your company employs staff, including yourself as a director, you must set up a Pay As You Earn (PAYE) system to collect Income Tax and National Insurance contributions. This system requires regular reporting to HMRC and strict adherence to payroll deadlines.

Transitioning from a sole trader to a limited company is a significant step that can offer numerous benefits, including limited liability, tax efficiency, and a professional image. However, it comes with increased responsibilities and legal requirements. By understanding the key differences and steps involved in this transition, you can make informed decisions to facilitate the growth and success of your business.

SWIG Finance offers Start Up Loans from £500 – £25,000 and Business Loans from £25,001 – £250,000 to SMEs in Swindon & Wiltshire and Bristol & Bath.