A first-time business owner will almost always opt to create a sole trader business, but when said business grows, a transition to a limited company starts to make sense. There is a wide range of employee and tax benefits to be had, like limited companies’ ability to claim tax relief for a wide range of business expenses, as well as benefits from the lower bracket corporation tax, which offers high levels of tax efficiency. But there are a lot of things to consider when making the switch, especially the transfer of your business assets.
This article will explain what is required when changing from a sole trader to a limited company, and how to transfer your assets legally and cost-effectively.
Table of Contents
What Is A Sole Trader?
Sole traders run their business as individuals, operating as freelancers, consultants, contractors or a one-person business. They have no formal legal structure and are liable for all business expenses and debts. It requires far less administration to run as a sole trader than a limited company, and there’s less formality inherent to a business than a limited company. The one main advantage of being a sole trader is complete freedom in flexibility. As lower tax brackets, you pay tax as a lower rate of corporation tax, long before the income tax bracket reaches its maximum of 60% as your income rises. Sole traders begin to think of making the switch to the limited company structure before this point.
What Is A Limited Company?
Limited companies are a separate legal entity status, meaning that the company is responsible for its debts. This provides financial protection for the personal assets of the owners, company directors and other leadership positions, and is considered the biggest benefit aside from corporation tax implications. Companies pay corporation tax that is typically capped at 19% or 25%, except in cases of tax punishments. This is much less tax than the possible 60% for sole traders. Bear in mind that profits you withdraw from the company will still impact personal tax, and you’ll need to reflect this in your tax return.
Other benefits include having access to more financing options, such as business loans via a bank, as well as wider investment opportunities from low-risk options such as high-interest savings accounts and corporate bonds, to higher-risk options of venture capital trusts and individual stocks. By becoming a limited company, you are obligated to provide disclosure to the public of a lengthy amount of details, such as accounting records that show significant detail (making it possible to roughly determine the director’s salary), director and shareholder information etc.
The main downside to a changing business structure from sole trader to limited company is the loss of control, due to shareholder rights, and the requirement to expand administration and install a company director.
What Is The Process Of Changing To A Limited Company?
The process of changing from a sole trader to a limited company can be more difficult than you might expect. It requires:
- A Transfer of Assets – The first step is getting all the assets transferred into your new name, which may require you to go through some red tape with HMRC and Companies House.
- Administration – You will be required to submit records about the transfer at both Companies House and HMRC for them to update their records accordingly. Such documents include:
- Form TR285 – for change of directors.
- Form SH01 – for change of shareholders/share allocation.
- Other forms – depending on the specific changes (e.g., change of company name or registered office address)
- Employee – Inform and provide your customers, suppliers and stakeholders with information on the changes, especially for employees and how this change affects things like paycheques or pension contributions.
What Kinds Of Assets Are Usually Transferred, And How?
Except for businesses that have already been a limited company (as it is possible to switch vice versa), the types of assets that are usually transferred are going to be money and property. This can change depending on your industry, such as:
- Creative industries – Intellectual property, clients and lists etc.
- Manufacturing and retail – Inventory and stock, equipment and machinery etc.
- Service industries – Client relationships, software licenses etc.
- And more.
Which Assets Are Subject To UK Capital Gains Tax (CGT) When Switching?
Various assets are subject to UK Capital Gains Tax (CGT) when changing from a sole trader to a limited company. When transferring a sole trader business to a new company, it is important to consider the potential tax implications related to CGT. These include shares, property, and land that is not being used for business purposes.
What Are The Potential Reliefs From CGT?
- Incorporation Relief – This is available to people who have started a new business or are taking over the assets of an existing one. It’s often used by individuals who want to transfer ownership from sole trader status. Incorporation relief is a tax-efficient opportunity that can provide significant tax-saving benefits.
- Entrepreneurs’ Relief – This applies if at least one person owns more than 25% of the company when transferring into limited company status. This means there will be no capital gains tax charge on those transferred assets because they qualify for 100% exemption under section 109 TCGA, 1992.
- ‘Hold-over’ Relief – This applies if you have started trading with some assets before the date on which your company changes from a sole trader to a limited company. In this case, HMRC would not charge CGT for those specific assets that are being transferred over.
Best Practices For Changing From A Sole Trader To A Limited Company
There are a series of steps to go through to transfer these assets, however:
- Professional Help – Talk to an accountant and a lawyer who understands the implications of changing to a limited company for your business type and take their advice on any legal or tax aspects.
- Value Assets – Identify and value the assets in a comprehensive list, both tangible and intangible with the land registry. We recommend hiring a qualified appraiser/surveyor. Consider transferring intellectual property and trademarks.
- Legal Documentation – Draft contracts and agreements that detail the transfer of each asset.
- Date Change – Decide on a date to change over – the sooner you do it, the more time you have to plan your tax position and get everything in order.
- Transfer Ownership – Execute the transfer of funds from the sole trader business bank account to the company bank account. Complete all transfer deeds and update ownership details of your intellectual property.
- Prepare Ahead Of Time – Get all paperwork together so that when the day comes for changing over, there is no last-minute rush or panic with missing documents.
- New Regulations – Learn about any new regulations that may apply after becoming a limited company: accounting requirements, VAT etc and make sure these are being met before transferring assets.
- Capital Gains Tax – Find out which assets are subject to UK Capital Gains Tax charges ahead of time.
- Account Creation – Set up business bank accounts to keep business and personal finances separate. Operating a business bank account can simplify bookkeeping and accounting, and many leading banks offer a selection of business bank accounts tailored to your needs.
Where Can You Get Advice Before Making The Switch?
There are several places you can get advice before making changes to a limited company. One option is to contact an accountant or a lawyer, who will be able to advise on the legal and tax implications of your change in status. Another option is to talk to an organisation such as The Association for Legal Professionals (ALP), which offers free expert support from qualified accountants, lawyers and HR experts. There are also websites like Company Wizard that provide information about how to set up a limited company or sole trader in the UK.
Conclusion
Changing from a sole trader to a limited company can have many benefits, but to transfer all your assets correctly, you need to follow the correct steps. Make sure that all documents about ownership of your assets are in order, and that you have checked the tax regulations regarding each type of asset you plan to transfer. If this is your first time starting a limited company, it may be worth spending a little money on a lawyer or accountant (or both) who will be able to guide you through the process.
FAQ: What are the common difficulties encountered when switching to a limited company?
Sole traders sometimes find issues when transferring assets when the assets didn’t originally belong to them. In that case, you will have to execute a formal legal process known as an assignment, which may involve updating existing documentation referencing the assets from before they gained them. If there’s no legal document assigning ownership, then technically anyone can claim them.
