How to change from sole trader to limited company

Thinking of making the switch from sole trader to limited company? This guide will help you understand how to do it.

Financial software shown on open laptop

What’s the difference between a sole trader and a limited company?

When you start a business, one of the first decisions you have to make is whether to register as a sole trader or a limited company.

There are pros and cons to being a sole trader or a limited company. Many small businesses and self-employed people start out as sole traders, as it is the simplest way to set up — but there may come a time when you want to change from being a sole trader to a limited company.

Some of the main differences between operating as a sole trader and a limited company are:

Sole trader

  • You and your business are legally the same entity
  • Registered through HMRC
  • Retain all profits made after tax
  • Complete an annual Self Assessment tax return
  • Pay income tax and National Insurance on profits
  • Your financial information remains private

Limited company

  • Your business is a separate legal entity to you
  • Registered (incorporated) with Companies House
  • Pay yourself a salary and/or dividends from business
  • File annual company accounts, plus Self Assessment for your personal tax
  • File a Corporation Tax return (CT600) and pay Corporation Tax on profits
  • Your business’s financial information may be accessible to others via Companies House – there are exemptions for companies classed as mico-entities or small companies.

What are the benefits of changing from sole trader to limited company?

There are several advantages to switching from a sole trader to a limited company:

1. Limited liability

Because your limited company is a separate legal entity, you are not personally liable for any losses made by the business. If your business fails and incurs debt, you only stand to lose company assets, not personal assets, such as your home. An exception to this is if there is a case of director misconduct.

2. Tax efficiency

Instead of paying income tax (at 20-45%), you will pay Corporation Tax as a limited company, which is currently 19% — so, depending on your profits, you might pay a lower rate.

Your business therefore needs to reach a certain profit threshold before being incorporated becomes more efficient than being a sole trader.

The Chancellor of the Exchequer recently announced that corporation tax will rise to 25% for companies with taxable profits above £250,000 in April 2023. Companies with taxable profits between £50,000 and £250,000 will pay tax at the 25% rate reduced by a marginal relief calculation. Those with profits under £50,000 will continue to pay 19%.

As a limited company you will be liable to pay National Insurance if you pay yourself a salary above the NI threshold (currently £11,908 across the 2022/23 tax year).

Some limited company directors pay themselves a lower salary and take more of their income from dividends.

3. Increased opportunities

Lenders and investors can sometimes favour limited companies over sole traders. Some companies and organisations choose not to work with sole traders, so being a limited company could increase your options.

What are the disadvantages of switching to a limited company?

While there are many advantages to being a limited company, there are some drawbacks to consider, such as:

1. Increased admin

Setting up as a limited company is more complicated and time-consuming, with increased paperwork and admin involved.

2. Less privacy

You have less privacy over your business finances. Company accounts are a public record and can be accessed by anybody.

3. Higher accounting costs

Your accountancy costs may be higher as a limited company due to the additional reporting required.

How to become a limited company

The process of becoming a limited company is known as incorporation. You should speak to an accountant before deciding to make the switch, as they can advise you of the pros and cons for your business.

If you do decide to change from a sole trader to a limited company, here is what you need to do:

  1. Choose a name for your company. The rules are different for this than for a sole trader — for example, you cannot have the same name as another registered company.
  2. Register the limited company with Companies House (there is a fee of £12 to do this). You will be registered for Corporation Tax at the same time.
  3. Let HMRC know that you will no longer be a sole trader. You’ll need to complete a final Self Assessment by 31 January after the end of the tax year.
  4. If you plan to pay any salaries to directors (including yourself) or employees, you will need to register as an employer and set up PAYE (unless none of your employees are paid £123 or more a week, get expenses and benefits, have another job or get a pension – but you will still need to keep payroll records).
  5. Set up a separate business bank account for your limited company.

How long does it take to set up a limited company?

Once you have registered online your company is usually incorporated within 24 hours.

Is it worthwhile converting from sole trader to limited company?

The decision to change from a sole trader to a limited company should be considered carefully. Your business turnover, personal circumstances, and individual preferences all need to be taken into account when deciding if it's the right move, and you should seek advice from an accountant, who will be able to guide you accordingly. In the meantime, if you want to understand more about how Making Tax Digital for Income Tax will impact you as a sole trader, take a look at our expert FAQs or dedicated resource hub.

Start using Xero for free

Access Xero features for 30 days, then decide which plan best suits your business.

  • Included
    Safe and secure
  • Included
    Cancel any time
  • Included
    24/7 online support