Switching from Sole Trader to Limited Company

Many UK businesses start as sole traders because it is the simplest way to begin. No registration fees, no Companies House filings, just register for Self Assessment and start trading. But as your profits grow, the tax savings from operating as a limited company become harder to ignore.

This guide covers when to make the switch, how to do it and what changes once you have.

When does switching make sense?

The main driver is tax. As a sole trader, all your profits are subject to Income Tax and Class 4 National Insurance. As a limited company director, you can split your income between salary and dividends, which carries a significantly lower tax burden.

Tax comparison at different profit levels

These figures assume the director takes a salary at the personal allowance (£12,570) and the rest as dividends. The limited company figures include Corporation Tax at 25% on the profits before extraction.

The crossover point where a limited company starts saving you money is typically around £25,000-£30,000 of annual profit. Below that, the additional administrative costs of running a limited company (accounting fees, Companies House filings, payroll) may outweigh the tax savings.

Other reasons to incorporate

Tax is not the only factor. There are several non-tax reasons to become a limited company :

• Limited liability – your personal assets are protected from business debts (in most circumstances)
• Professional credibility – some clients prefer to work with limited companies
• Easier to raise investment – you can issue shares to investors
• Pension contributions – employer contributions are more tax-efficient through a company
• Business continuity – the company exists independently of you

The incorporation process

Step 1: Register the company

Register your new limited company at Companies House. You can do this online for £12 (standard service, usually processed within 24 hours) or £30 for same-day incorporation.

You will need:

• A company name
• A registered office address
• At least one director (you)
• At least one shareholder (usually also you)
• Details of share capital (typically 100 ordinary shares at £1 each)
• A Standard Industrial Classification (SIC) code describing your business activity
• Articles of association (the default Model Articles work for most companies)

Step 2: Register for Corporation Tax

Notify HMRC within three months of the company starting any business activity. HMRC will issue a Unique Taxpayer Reference (UTR) for the company.

Step 3: Set up payroll

If you are going to pay yourself a salary (and you should – see our guide on directors’ salary ), you need to register as an employer with HMRC and set up PAYE.

Step 4: Open a business bank account

Your limited company is a separate legal entity and needs its own bank account. You cannot use your personal account or your sole trader account for company transactions.

Step 5: Transfer the business

You have two main options for transferring your existing business to the new company:

Incorporation Relief (under Section 162 TCGA 1992) defers any capital gains tax on the transfer, provided you transfer the business as a going concern (including all assets) and receive shares in the new company as the whole or part of the consideration. This is the most common route and in most cases means no immediate CGT to pay.

Step 6: Notify your contacts

Let customers, suppliers, your bank and any regulatory bodies know about the change. Update contracts, invoices and terms of business to reflect the new company name and details.

VAT considerations

If you are already VAT-registered as a sole trader, you have two options:

Transferring the VAT number is usually the better option. It avoids a gap in VAT registration, preserves your filing history and means your existing customers do not need to update their records.

If you are not VAT-registered and your turnover is below the £90,000 threshold, you can choose whether to register the new company voluntarily. If most of your customers are VAT-registered businesses, voluntary registration lets you reclaim input VAT on your purchases.

What changes day to day

The additional administration is real. You will need to:

• Run a payroll (even if you are the only employee)
• File annual accounts at Companies House
• File a confirmation statement at Companies House each year
• Maintain a register of shareholders and directors
• Hold and minute board meetings (in practice, a written resolution is sufficient)

Closing your sole trader business

Once you have transferred everything to the limited company:

• File a final Self Assessment tax return for your sole trader income up to the date you stopped trading
• Notify HMRC that you have ceased trading as a sole trader
• Cancel your Class 2 NIC registration
• If you were VAT-registered as a sole trader and did not transfer the number, submit a final VAT return and deregister

Do not forget to account for any overlap relief you may be entitled to. When you started as a sole trader, you may have been taxed twice on some of your early profits (due to the basis period rules). This overlap relief is given when you cease trading.

Corporation Tax and the small profits rate

As a limited company, your profits are subject to Corporation Tax :

For most businesses switching from sole trader to limited company, the small profits rate of 19% applies. Combined with the dividend tax rates (which are lower than Income Tax rates), the total tax burden is substantially less than paying Income Tax and NIC as a sole trader.

Timing the switch

The best time to incorporate is usually at the start of a new tax year (6 April) or at a natural break in your business cycle. This keeps your sole trader and limited company accounting periods clean and avoids the complexity of mid-year transitions.

If you have already earned significant profits in the current tax year as a sole trader, waiting until the next tax year to switch avoids having to deal with two sets of accounts for the same period.

Costs of running a limited company

The total additional cost is typically £600-£2,500 per year. If your tax saving exceeds this, the switch is financially worthwhile.

Making the decision

The numbers usually tell the story. If your annual profits consistently exceed £30,000 and you expect them to stay there, the tax savings from a limited company will almost certainly outweigh the additional costs and administration. For profits below £25,000, staying as a sole trader is often simpler and just as cost-effective.