Incorporating your business
If you are currently trading as a sole trader or through a partnership, have you considered incorporating your business? As with most things there are both benefits and drawbacks which need to be weighed up to decide if a limited company is right you for you.
Some of the benefits a company are:
A limited company is a separate legal entity to you, meaning your business liability is separate from your personal one. The advantage is that if the company has problems with its finances, these should not affect you personally. With the relatively gloomy economic forecast this might look very appealing. However, please note that personal guarantees from the directors themselves are often sought from lenders and landlords.
Trading through a company can bring some tax savings especially where you are able to let profits accumulate within the company rather than extracting them as directors’ income. Higher or additional rate taxpayers can see the greatest financial benefits from this strategy.
Trading through a company can give your business more credibility in the marketplace.
Flexibility of profit extraction can have advantages. Putting a small director’s salary through a payroll scheme utilises personal allowances and also ensures the National Insurance record is topped up with qualifying years towards your state pension entitlement. Different classes of shares can mean that dividends can be set in a tax efficient way between family members with differing marginal tax rates.
Interest paid on money loaned to a company by a director can be a tax-efficient method of extracting funds. Directors’ loan accounts can build up over time from the initial capital injection, expenses paid personally or dividends declared but not yet paid, etc. Interest is a tax-deductible expense for the company. Depending on the income of the director, some or all of the interest might be chargeable to Income Tax at 0% because of the Saving Allowance and the Starting Rate for Income Tax. Even when these have both been fully utilised, interest may still be more tax efficient than a dividend, because the latter does not attract tax relief for the company.
As a director (employee) of your company, employer pension contributions can be a very tax efficient way of extracting profits from a company.
Taxpayers have a £2,000 dividends allowance. Only dividends received in excess of the allowance are taxable on the recipient.
Where a small business trades below the £85,000 turnover VAT registration threshold, incorporation can extend the need to register for VAT. The previous turnover of the unincorporated business is not counted for this purpose as long as it did not exceed the threshold.
Unlike sole traders and partnerships, companies are being encouraged to invest in plant and machinery through additional tax relief. However, this ‘Super-deduction’ is to end on 31 March 2023. Companies investing in qualifying new plant and machinery will be able to benefit from 130% first-year capital allowances. They will also benefit from a 50% first-year allowance (rather than a 6% Writing Down Allowance) for qualifying special rate assets, which are those with an expected economic life of more than 25 years or fixtures within a building.
A limited company can raise finance by selling shares to friends, family or other investors.
Obtaining funding can be more challenging for sole traders and partnerships.
Companies can be useful in succession planning as shares can be issued to loved ones or left in a Will.
There are also problems to consider:
The burden of compliance is far greater with a company. Accounts and other documents must be filed with Companies House in addition to those which need to be submitted to HM Revenue & Customs. This creates additional compliance costs with multiple deadlines to be met and failure to do so could result in financial penalties. Legislation dictates how company accounts should be prepared. These are much more detailed than those for sole traders and partnerships.
Filing with Companies House puts information about your business in the public domain. We file abbreviated accounts for our clients to keep the public information to a minimum.
Where profits are low, the additional costs associated with trading through a company will outweigh any small potential tax saving.
Directors have legal duties to fulfil and failure to do so could render directors personally responsible.
Please do not overlook the practical points. Contracts formed outside the company will need to be transferred. If the incorporation will involve property, conveyancing costs, stamp duty and capital gains tax need to be factored into your decision.
Business owners need to stand back and look at the bigger picture. If there is a plan to cease trading in the short term, the costs of incorporation will probably be restrictive. However, with long term plans, it might well be an avenue well worth exploring.
Adam, our managing director, specialises in companies. Please give him a call on 01756 799823 or email firstname.lastname@example.org so he can look at how a company might work for you.