Tax changes have made it even more important to consider carefully, when running a business, whether it is best to trade as:
- Sole trader – an individual
- Partnership – two or more individuals or companies
- Limited liability partnership
- Limited company
I am often asked, ‘Should I form a limited company?’ However, without knowing more information, it is a question that is impossible to answer as each situation has to be judged individually. Yes, there are obvious savings to be made in your effective rate of taxation (should you be a higher rate tax payer) but there are many other factors to consider, ones that I view as more important than your effective rate of taxation, such as:
- The business
- Its expected rate of growth
- The profitability of the business
- The likely profit trend
- The degree of commercial risk
- Administrative obligations
- Personal preferences
- Pensions and retirement
In the early years of a business, the privacy and fewer administrative obligations of operating as a sole trader or partnership may be attractive. But some entrepreneurs become to, well, too ‘hung up’ on privacy. Yes, a company has to file accounts at Companies House, but at worst, does it really matter is someone knows the size of your business?
Personally, I believe in transparency of information, but that is a whole different blog. Now coming back to privacy, a small company effectively only has to file a balance sheet, a frankly, this will tell the reader very little. Moving onto administration, their really isn’t much more to administering a company, partnership or LLP than there is for you are a sole trader and we take care of most of that for you. However, what we are considering here are the consequences of incorporating or not. Hence lets start with a fundamental premise, a company is a completely separate legal entity, subject to two main areas of regulation – tax and company law. This blog looks at some of the advantages and disadvantages of trading as a limited company from both perspectives and from a commercial perspective. After all, that’s what we do best, add commercial common sense to your business.
Possible advantages of incorporation
- Incorporation normally provides limited liability. If a shareholder has paid fully for his or her shares, he or she cannot normally be required to invest any more in the company, should the worst happen and it is faced with insolvency. Although some forms of credit, such as leases for equipment, cars and premises, together with bank finance often require a directors’ personal guarantees. Hence the protection of limited liability will generally apply in respect of liabilities to other creditors.
- A company enjoys legal continuity – it can own property, sue and be sued.
- Effective ownership or part ownership of the business may be readily transferred – and this is what we love! But, (there’s always a but) such transfers may well trigger inheritance tax or capital gains tax, hence why we need to understand your goals and plans.
- External investors may be entitled to the tax breaks available through investing in the company using the Enterprise Investment Scheme or the Seed Enterprise Investment Scheme – two schemes that we LOVE!
- Shareholders can be paid in dividends (Free of National Insurance Contributions).
- The national minimum wage does not apply to directors (as they are office holders) unless they have a statement of terms and conditions of employment.
- Growing businesses can re-invest profits after a corporation tax charge of 20% (if profits are below £300,000), compared with 40% for higher rate or 45% for additional rate tax paying sole traders and partners together with a 2% class 4 national insurance charge on profits over £41,865.
- Accumulated funds could be withdrawn on a sale of shares with the benefit of a 10% effective rate of tax on the first £10 million of capital gains. Thereafter any gain is chargeable at either 18% or 28%. WE LOVE THIS TOO
- You can sell your existing business to a company that you own and trigger a capital gain, thereby paying a 10% effective tax rate or defer capitals gains tax on the transfer of goodwill. WE LOVE THIS BEST
- Corporate status is sometimes thought to add to the credibility or commercial respectability of the business.
- A company can incentivise staff through tax advantaged share options issued under the Enterprise Management Incentives scheme.
- Employees may, with adequate safeguards, be offered an opportunity to buy their own stake in the business, reflecting their commitment and importance to the company.
- The liability of executors acting for deceased shareholders, or of trustees, is clearly defined.
Possible disadvantages of incorporation
- Formation of a company incurs legal and administrative costs, which may include new accounting records and possibly systems, new PAYE system, new business tax reference, new VAT registration, requirement to file a corporation tax return.
- Customers, suppliers and service providers must be informed of a change to limited company status.
- Annual accounts must comply with the requirements of the Companies Act. In most cases, a statutory audit is not required for companies with an annual turnover of £6.5 million or less.
- A company’s accounts must be filed on public view with the Registrar of Companies. An Annual Return must also be submitted to the Registrar of Companies together with a filing fee.
- There is a severe penalty regime in force for failure to file on time.
- An individual has greater flexibility in dealing with trading losses.
- A company director is more at risk of criminal or civil penalty proceedings, e.g. for late filing of accounts or for breaching the insolvency rules.
So should you incorporate or not? Our view…..it depends