Should I incorporate my business?
One of the most frequently asked questions by sole trader or partnership businesses is as to whether they should incorporate their business to that of a limited company.
Each individual will have to assess their own needs and seek their own advice with regards to the benefits of incorporating however in summary some of the advantages and disadvantages are as follows:
- 1. Limited liability (subject to personal guarantees provided)
- 2. Small business tax savings
- 3. Credibility
- 4. Raising money
- 5. Income control / distribution
- 1. Additional compliance
- 2. Costs of incorporation
- 3. Directors legal responsibilities
- 4. Information on public record
Clearly the taxpayer will have their own beneficial reasons to incorporate and the above lists are not necessarily exhaustive, however they do highlight some of the more frequent questions.
For the pupose of this article, we will look at some of the tax advantages of incorporating.
Taxation of company profits
For the current tax year a company is taxed at 21% on profits up to £300,000. For individuals (after personal allowances) tax is at 20% for the first £37,400 along with 8% national insurance charge. For profits over this amount the tax rate is 40% (plus1% national insurance) rising to 50% for profits greater than £150,000. There is also a phasing out of personal allowances for high earning individuals. Clearly, to reduce the tax burden of the business, the reduced limited company rate will appeal to many taxpayers.
Payments on account
For individuals paying tax under self assessment there is a requirement to pay 50% of the previous year’s tax liability in January with a further 50% payable in the following July. This can cause cash flow constraints on a business. However a limited company only pays tax on its profits 9 months after its year end. Careful tax planning of how a company pays its directors / shareholders could mitigate the requirement to make such payments on account.
This is a more complex area and individuals will need their own personal advice with regards to the position of goodwill. For a business already in business the transfer of operations to a limited company may trigger a capital gains tax charge on the individual for the value of the business over and above the value of its surplus assets. This is goodwill and with entrepreneurial relief this could result in a personal tax charge of approximately 10% but allow the vendor to be paid this as a loan repayment from the company on a tax free basis. For businesses started after 1 April 2002 the company may be able to obtain corporation tax relief on the write off of its goodwill value, depending on how it is written off within the financial accounts. Of course HM Revenue and Customs will keep a close eye on potential overvaluations, and if they deem it to be the case, could charge the individual on the excess as employment income.
Business start up
Recently more and more individuals are setting up their own businesses, frequently using the proceeds of redundancy packages to finance the business start up. Whereas the company route does have tax savings, they are somewhat restricted when it comes to losses which can so often occur in the first year or two of trade. For companies, these losses can only be carried forward against future profits, however, for an individual incurring losses in the early years of trade, the losses can be carried back against other income earned in the previous 3 years. For an individual who was a higher rate tax payer in these periods, this could generate a 40% refund which could assist cash flow.
Clearly the age old question of "should I incorporate" remains. I have outlined some key thoughts and looked at certain tax considerations, however I strongly recommend that you discuss your personal circumstances with your professional advisors before deciding.
Contributed by JDB Accountants