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.
How the comparison works
A sole trader pays Income Tax and Class 4 NIC on all profit. A company pays Corporation Tax on its profit, and the director then pays personal tax only on what is taken out as salary or dividends. A common pattern is a salary at or near the personal allowance, with the rest taken as dividends taxed at the lower dividend rates. The gap between the two routes tends to widen as profit rises, until most profit is taken out at higher rates.
The size of the saving depends on the Income Tax, National Insurance, Corporation Tax and dividend rates for the year, so the comparison should be recalculated with the current figures rather than taken from a fixed table.
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:
| Method | How it works | Key consideration |
|---|---|---|
| Sale of the business | You sell the business assets to the company at market value | May trigger capital gains tax on the sale, but Incorporation Relief can defer this |
| Gradual wind-down | Stop trading as a sole trader and start trading through the company | Simpler, but does not transfer existing contracts or goodwill |
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:
| Option | What happens |
|---|---|
| Transfer the VAT number | The company takes over your existing VAT number. Useful for continuity. |
| Cancel and re-register | You deregister as a sole trader and the company registers for VAT separately. |
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
| Area | Sole trader | Limited company |
|---|---|---|
| Tax returns | Self Assessment (personal) | CT600 (company) + Self Assessment (personal, for salary and dividends) |
| National Insurance | Class 4 (Class 2 only if paid voluntarily) | Employer and employee NIC on salary only |
| Accounting records | Can be simpler | Must keep statutory records and file annual accounts |
| Profit extraction | All profit is yours | Must be extracted as salary, dividends or pension contributions; personal withdrawals go through a director’s loan account |
| Public filings | None | Annual accounts and confirmation statement at Companies House |
| Personal liability | Unlimited | Limited to share capital (in most cases) |
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
- Tell HMRC you have stopped being self-employed
- If you were VAT-registered as a sole trader and did not transfer the number, submit a final VAT return and deregister
Under the old basis period rules, unused overlap relief used to be given when you ceased trading. The basis period reform used up remaining overlap relief in the 2023/24 transition year, so most sole traders who stop now have none left to claim.
Corporation Tax and the small profits rate
As a limited company, your profits are subject to Corporation Tax:
| Profit level | Corporation Tax rate |
|---|---|
| Up to £50,000 | 19% (small profits rate) |
| £50,001 to £250,000 | Marginal rate (effective 26.5%) |
| Above £250,000 | 25% (main rate) |
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
| Item | Typical annual cost |
|---|---|
| Accounting fees | £500-£2,000 |
| Companies House confirmation statement | The current Companies House filing fee |
| Payroll processing | Included in accounting fees or £50-£200/year |
| Company insurance (directors’ and officers') | £100-£300 |
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.