subject: The Advantages and Disadvantages of Incorporation [print this page] The Advantages and Disadvantages of Incorporation
Usually incorporation is promoted by your accountant.
If losses are to be made in the first year of trade they are relieved more effectively as a sole trader as opposed to being made in a limited company.
The advantages and disadvantages of an incorporated status are as following:-
You must consider these in association with your own circumstances. .
Advantages:
You can shelter tax at 20% rather than current rates of 40% or 50% depending on your income level and spending requirement. By that I mean that to achieve the largest saving you need to be able to leave money in the company. That is you do not need to withdraw the whole of the profits made to meet your living expenses.
I call this the money box strategy.
As long as you withdraw the profits made using a mixture of low salary and the balance as dividends there will savings of National Insurance. Watch for the affect on any possible Tax Credit claim.
Dividends are distributions of company retained profits after payment of the corporation tax. You only pay further tax personally if you are liable at higher rates of tax i.e. 40% or 50%
The major reason for incorporation is the commercial protection it provides. Unless you give personal guarantees your personal liability is restricted to the amount of your share capital. Nobody can predict the future so wrap a company around your business and you will be at less risk of personal bankruptcy. .
Some people find the requirement to register for VAT an unwelcome event and there are ways that registration can be avoided by splitting the business or otherwise using a company. It is important that you take good professional advice before using this strategy in tandem with a sole trader/partnership business.
HM Revenue & Customs will examine these structures carefully.
You can share the business profits amongst the family. This can be done by having a different class of shares or transferring shares amongst the family.
This is one of the easiest tax mitigation strategies as each member of the family has a personal allowance and the various bands of tax liability. An LLP is a more flexible vehicle than a limited company but do not use an LLP without professional advice.
Credibility; I do not understand why some businesses would rather trade with a company than a sole trader or partner because if someone owed me money it is usually the person that has the assets and not the company. However many companies see a company to have more credibility.
On incorporation if relief is not claimed under S162 TCGA 1992 consider sellingthe goodwill of your unincorporated business to the company.
You will be charged capital gains tax but this can be paid out of the money you can withdraw from the company tax-free; i.e. the amount of the purchase price.
You may also be entitled to entrepreneur's relief. The company may also be able to claim a write down of this expenditure against its profits.
The sale of shares gives rise to capital gains tax with, subject to qualifications, tax is due at 10% and this should be planned to be exploited.
There is a strategy to withdraw retained profit as dividends and pay no tax.
If you have a balance owing to you on your director's loan account you can pay yourself interest at a commercial rate and thus avoid national insurance.
If the company uses assets in the business that you own you can charge rent to the cany and again save national insurance.
Disadvantages:
A limited company is a more formalized structure and is regulated by Companies House.
You must file the company accounts with Companies House within nine months of the company year end. There are penalties for the late filing of the accounts.
They are then available to be viewed by the public at large.
You will find that generally the fees charged by your accountant are higher than if you are a sole trader or a partnership.
When an asset is used in a personal business the restriction for the personal use is less restrictive than the regime of benefit in kind for assets provided by a company.
As a director the financial relationship between you and your company is accounted for through the director's loan account. I would suggest very few directors of small companies know the actual position of their account and this causes tax problems.
It is important as if you owe the company money, that is you have drawn more money from the company that you have either put in or earned as your share of the profit, the director's loan account is then overdrawn.
Another consequence is the company has a liability to tax of 25% of that overdrawn amount. You as director would also have a personal liability on a benefit in kind on interest equal to a percentage of the overdrawn amount. So take care and monitor the balance on your director's loan account on a regular basis.
If losses are made in the early years of the business they can be more effectively used if made as a sole trader as opposed to them arising in a limited company. The reason is that as a sole trader they can be set back against the income of the three years before the trade commenced and this usually results in a repayment of tax at this important time when cash flow is crucial.
In a company they are basically carried forward and set against the profits of future periods.
Companies have been used for many years to reduce the tax payable in the unit of two spouses or partners. HMR&C continue to attack this strategy and have used the Courts so far with minimum affect.
A succession of governments has indicated that they are to legislate to avoid this loss of tax. They are finding this difficult and what is more it is difficult to see how they can challenge every company with the continuing reduction in their staff numbers.
Take care not to give personal guarantees for company liabilities such as bank or other borrowing as these defeat the benefit of having the company in the first place.
When a company is in financial difficulties do review the PAYE position for it is only the PAYE for your employees that you can dump. You as director could remain liable for any tax and national insurance that should have been deducted from your remuneration.
You could have problems if you do not correctly deal with the voting and paying dividends.
Watch each time you form a new company as the associated company rule results in the small company rate band being shared between the associated companies. (Section 25 CTA 2010).
