By Sharron Fletcher CTA, partner at RAE Business & Property
I was asked at least three times this week by sole traders, ‘Should I incorporate?’.
Sometimes the answer is fairly straightforward, like the time a sole trader who had just started his business and wasn’t sure whether he was still going to be a sole trader in a year’s time. It was clear that the cost of incorporating, plus the possible winding up of the company in a year’s time, would outweigh the potential tax savings of incorporation. There was the benefit of limited liability that incorporation offers to consider, but adequate professional indemnity, public liability and employer liability insurances usually covers this concern. However, if you carry out a high risk business to the public, employees or consumers, incorporation may be advisable in any event, as if insurances do not cover the legal claim, the excess will fall on the company and not you.
However, usually the answer is not straightforward and requires careful consideration of the advantages and disadvantages of incorporation. Every situation is unique, and there is no standard answer to this question.
So, what are the main advantages?
- Limited liability – as an owner, your assets will not be affected if the company were to get into financial trouble, except when you’ve signed a personal guarantee. Such guarantees are likely to be required by banks or for commercial leases, so this advantage generally applies in respect of liabilities to other creditors.
- Tax efficiency – corporate tax rates are lower than the highest personal tax rates. This means that if profits reach a certain threshold, a corporate structure would allow you to pay lower taxes compared to a sole trader or partnership.
- Funding – it’s much easier to raise funds through a limited company and different classes of shares means you can offer investors different rights to dividends, and have different amounts of control over the company.
- Transfer of ownership – Effective ownership of the business may be readily transferred or it may be possible to dispose of a part interest in the business to a purchaser in the future.
Other advantages include that a company enjoys legal continuity, so it can own property, sue and be sued. Also a company can establish an approved pension scheme which can provide greater benefits than self-employed schemes and employees can be offered the opportunity to purchase shares in the company. Friends and family can also invest in your company and take shares in return.
- Costs are incurred on the setting up of a company and there are annual administrative costs.
- The costs of preparing annual accounts are greater for a limited company as the accounts have to be in a prescribed format and comply with the Companies Act.
- Directors will be taxed under PAYE with higher NI contributions than for the self-employed
- The company will have to pay employers’ NI contributions, but the introduction of the £2,000 employer’s allowance has eased this burden.
- Dividends do not go towards pensions. Although dividends can be paid and do not attract NI, they do not rank as relevant earnings for pension contributions.
- All shareholders are entitled to a dividend. If a dividend is declared, all shareholders are entitled to receive it unless there are different classes of shares or there is a formal dividend waiver procedure.
- There are much stricter regulations concerning employee and director benefits,especially in respect of cars.
It is strongly recommended that you talk through the issues with your accountant to make sure that you choose the structure that is most suitable for you.
Author: Sharron Fletcher CTA, partner at RAE Business & Property and can be contacted via email at firstname.lastname@example.org or call 07587 709008.
Published on 01 March 2015