To Incorporate or Not to Incorporate, That Is the Question!

We have been talking to lots of business owners since we launched in April, many of whom started trading or had to quickly pivot their business, as a result of the COVID-19 pandemic. Many of these business owners are sole traders or partnerships, as this was the quickest and easiest way to establish themselves in business when the pandemic hit. Now that their businesses are thriving, these business owners are understandably thinking about whether they should incorporate their sole trader or partnership business into a limited company. There are many pros and cons of incorporating, plus various tax implications that need to be considered, so we’ve included an overview of what you need to know below.

 

What are the benefits of incorporating?

 

• A limited company has a separate legal identity to its shareholders and directors, meaning that a company shareholder or director generally cannot be held legally liable for the actions of the company – this can be particularly beneficial once you start employing staff. It also means that the shareholders and directors are not financially liable for the debts of the company if it fails, whereas a sole trader or partner in a partnership would be held personally liable for the debts of the business if it were to fail.
• Running a business via a limited company gives the perception of being a bigger and more established operation, which can often be beneficial in attracting customers.
• There are greater opportunities for tax planning (see below) when operating through a limited company.
• Generally, limited companies have access to more lending opportunities than sole traders/partnerships, and certain banks will only lend to incorporated businesses.

 

What are the disadvantages of incorporating?

 

• A limited company has additional filing and compliance requirements compared to an unincorporated business. For example, companies must file annual accounts and confirmation statements at Companies House and also a corporation tax return with HMRC. This can add additional compliance and accounting costs that you wouldn’t incur as a sole trader or partnership.
• Companies are required to adhere to strict record-keeping requirements, including taking minutes of meetings and recording all decisions taken by directors and shareholders. Company registers and records must also be maintained and be available for public inspection at the company’s registered office.
• The personal information of directors and shareholders will be publicly available at Companies House.
• Strict procedures must be followed when shareholders withdraw money from the company and dividends can only be taken by shareholders if the company has sufficient distributable reserves. This means that if a company has been historically loss making, it is unlikely that shareholders will be able to take dividends from the company.

 

 

What are the tax implications of incorporating?

 

• As a self-employed individual, whether you are a sole trader or a partner in a partnership, you will pay income tax on your business’ profits each year, regardless of whether you have actually extracted any cash from the business. These profits are subject to income tax (at rates of up to 45%) and you will also pay Class 2 and Class 4 national insurance.
• As a shareholder/director of a company, you will only pay income tax on the amounts you extract from the business. If you are any employee/director of the company, you can pay yourself a salary, which would be subject to PAYE and Class 1 national insurance. As a shareholder of the company, you can also extract dividends, which would be subject to dividend income tax at rates of up to 38.1%.
• The company will pay corporation tax (currently 19%) on its profits and so there can be an element of double taxation on profits that are extracted from the company.
• When your sole trader or partnership business is transferred to the company, this could give rise to a chargeable gain for you personally based on the market value of the business assets transferred. In most cases, incorporation relief should be available so that you do not pay any tax on incorporation. Incorporation relief is available when all the business’ assets other than cash are transferred as a going concern, wholly or partly in exchange for shares in the new company.
• Depending on the assets being transferred to the new company, it should be possible for these to be transferred with no VAT implications providing that the relevant requirements have been met.

 

So, should I incorporate my business?

 

There is no doubt that incorporation will reduce your personal liability in the event of your business facing financial difficulty. A limited company also offers many tax benefits and there are numerous advantages to having a more professional image or status.

The benefits must, however, be weighed against the additional time and money required for the additional administration and accounting requirements you (or your accountant) will have to deal with.

 

How can BW Business Accountants & Advisers help?

 

We can provide you with tailored advice to help you decide whether incorporation is the right option for you. If you do decide to incorporate, we can help you to navigate the process and ensure that all the correct documentation is filed with the relevant authorities. We can also assist with the ongoing compliance requirements of your newly incorporated business.

If you would like to discuss your options then let’s talk!

 

Disclaimer: The tax rates and reliefs mentioned in this blog were correct at the time of posting (May 2021) and have not been updated for any future changes in tax law or HMRC practice. The contents of this blog have been produced as a helpful reference point and the information provided should be used as a guide only. You should discuss your specific circumstances directly with us before taking any action based on the information included in this blog.