Sole trader to limited company: what changes when you incorporate

Are sole trader and limited company really two different tax worlds?

Yes, and this is the single most important thing to understand. As a sole trader, you and your business are the same legal person. The profit is your income, and you pay Income Tax and National Insurance on it through Self Assessment once a year.

A limited company is a separate legal person of its own. It earns its own money, owns its own things, and pays its own tax, called Corporation Tax. You no longer pay tax on the business profit directly. The company does. You then pay personal tax only on the money you actually take out of it.

So incorporating is not a tweak to how you are taxed. It swaps you from one tax system to a completely different one, with different forms, different deadlines, and a different place to send them.

• Sole trader: Income Tax and National Insurance, paid through Self Assessment to HMRC.
• Limited company: Corporation Tax on company profit, paid through a Company Tax Return to HMRC, plus accounts to Companies House.
• You, the owner: personal tax only on the salary and dividends you take out of the company.

What happens to my sole trade when I incorporate?

Your sole trade does not carry on inside the company. In tax terms it stops, on the day the company takes over. HMRC treats that day as the date your sole trade ceased.

That means one last job for the old you. You file a final Self Assessment covering everything up to your cessation date, so the profit you earned as a sole trader right up to the handover is taxed properly and closed off. After that, you no longer file Self Assessment for the business, because the business is now the company's.

At the same time, the new company starts its own life from its first day. It keeps its own records, runs its own accounting year, and will file its own accounts and Corporation Tax return when the time comes. The two never share a tax return. One ends, the other begins.

This final sole-trade return is personal cessation tax, and it can have wrinkles (such as how your final year's profits are worked out). It is genuinely an accountant's job, not something we do for you. We pick things up once the company exists.

How do I take money out now I'm a director and shareholder?

When you set up a company you usually become two things at once: a director (you run it) and a shareholder (you own it). That gives you two normal ways to pay yourself, and most owners use a mix of both.

Salary

The company pays you a wage like any employer would. Salary is a cost to the company, so it lowers the profit that Corporation Tax is worked out on. To pay a salary, the company has to run payroll, which means registering for PAYE with HMRC (more on that below).

Dividends

A dividend is a share of the company's profit paid to you as an owner. You can only pay a dividend out of profit the company has actually made after Corporation Tax, never out of money it does not have. Dividends are not a company cost, and they have their own personal tax rates, which are lower than the rates on a salary.

The balance between salary and dividends is a personal tax planning question, and the right mix changes from person to person. We do not give that advice. What we do handle is the company side: making sure the salary the company paid is reflected correctly in its accounts and its Corporation Tax return.

What happens when I move the business into the company?

Your sole trade probably owns things: tools and equipment, stock, and often a built-up reputation and customer base, which tax calls goodwill. When the company takes over, those things move from you to the company. In tax terms, you are selling your business assets to a separate person, even though that person is your own company.

Because goodwill and equipment can be worth a lot, that sale can create a Capital Gains charge on you personally, on the rise in their value since you started. That sounds alarming, and it is the part people worry about most.

The relief that usually helps is called Incorporation Relief. Put simply, if you transfer the whole business into the company and take shares in return rather than cash, the gain is usually pushed into the cost of those shares instead of being taxed now. It is deferred, not deleted, and the exact rules matter, so this is firmly an accountant's territory. We flag it so you know to ask, but we do not advise on it or work out the numbers.

Why does my company's first year often need two tax returns?

Here is a quirk that catches new directors out, and it is one we do handle. When you set the company up, Companies House gives it a yearly date to count to, called the accounting reference date. It is the last day of the month you incorporated in, one year on. That means your very first accounts almost always run a little over 12 months.

Companies House is happy with one set of accounts covering that whole first stretch. HMRC is not, because a Corporation Tax return can only ever cover up to 12 months. So your first stretch is split into two tax periods, and you file one return for each: one for the first 12 months, one for the leftover days. One set of accounts, two tax returns.

From your second year onwards this goes away. Your year settles into a normal 12 months, and you are back to one set of accounts and one tax return.

What about PAYE and VAT?

PAYE, if you pay yourself a salary

As a sole trader you never ran payroll on yourself; you just drew money. A company is different. If it pays you a salary, it is acting as an employer, so it needs to register for PAYE with HMRC and report what it pays you. If you decide to take everything as dividends and no salary, you may not need PAYE at all. This is part of the salary-versus-dividends decision, so it is worth getting personal advice on.

VAT, if you were registered

If you were VAT registered as a sole trader, that registration belongs to you, not automatically to the new company. Usually the cleanest route is to transfer the business as a going concern, which lets the company take over the VAT position rather than starting from scratch. The rules here are specific, so check them before you assume the registration simply follows you across.

Where does SimpleReturns fit in all of this?

Once your limited company exists, we file its two yearly jobs: its annual accounts to Companies House and its Corporation Tax return (the CT600) to HMRC. If your first year runs long, we handle the split into two tax periods for you. That is the company side of your new tax world, sorted for one flat fee, no subscription.

We are honest about what we do not do. The final sole-trade Self Assessment, the cessation of your old self-employed business, the Incorporation Relief and Capital Gains side of moving the business in, and your personal salary-versus-dividends planning are all personal tax, and they belong with an accountant. We do the company's accounts and Corporation Tax return. For the once-only incorporation steps around them, get proper advice first, then bring the company to us.