You can choose to change your business’s status from sole trader to limited company at any time. Both formats have their pros and cons; the best choice will depend on a combination of your current situation and future plans. However, there may be an optimal time to make the switch, when the benefits of being a limited company outweigh those of being a sole trader.
So when might this be? Well, here are a few possible situations in which it might be the right time to make the switch, but it is important to calculate the potential benefits and savings before making the switch.
You may decide it’s time to make the switch if:
Your salary is increasing:
As a sole trader, you have only one way to take your salary, and that is as a salary, plus you must pay both income tax and national insurance contributions on it. A company director, on the other hand, can choose to take their wages in a combination of salary and dividends. Dividends are free from national insurance contributions. As a company director, you can reduce your taxes by taking a small salary and the rest in dividends, making it a more tax-efficient way.
You are looking for an investment:
If you are looking for investors, setting up as a limited company allows you to sell shares. Also, there is the perception that a company has more credibility than an individual, so many companies prefer to do business only with a limited company. As a result, potential investors are likely to be more open to investing in a limited company than in a sole trader.
You are concerned about liability protection:
As a sole trader, you and your business are considered one, and its debts are yours, so if your company fails, then you are liable for its debts. A limited company, on the other hand, is legally a separate entity from its owners, and so if your company fails, then your personal assets are not at risk, because as a shareholder you are not liable for its debts.
Your company profits start to grow:
When you trade as a sole trader, you are taxed through the annual self-assessment system, and you and your business are treated as one entity. A company, however, is taxed via the corporation tax system. There are potential tax savings to be made by switching to a limited company.
For example, for the 2016 -2017 tax year, as a sole trader your tax free allowance is £11,000, you the pay 20% tax on any amount between £11000 and £43,000, after which you are taxed a higher rate of 40%. However, for a limited company, the annual small profits rate is currently 20% on profits up to £300,000. So switching to a limited company may be more tax efficient because even though it is taxed at the same tax rate, it has a much higher maximum amount.
You want to protect your intellectual property:
By registering your company name with Companies House, you prevent any other person or business from using it, as it is now protected by law. However, as a sole trader, you don’t have this protection, so it can be much harder to protect your name.
There are some scenarios in which you might consider changing from a sole trader to a limited company, as doing so can result in savings and other tangible benefits. If you decide to switch, you need to notify HMRC that you are becoming a limited company and deregister as self-employed. From there, it is a simple process: register your business with Companies House, and then you can start trading as a limited company.