What type of Company should I set up?
With the ever changing tax rules and laws surrounding running a business, it is important to consider carefully what type of entity you should set up. The main choices are:
- Sole trader – an individual
- Partnership – two or more individuals or companies
- Limited liability partnership
- Limited company
A new business entrepreneur often asks, ‘Should I form a Limited Company?’ In reality, there is no easy answer. Each situation has to be decided on an individually basis. As well as the obvious issues of tax and national insurance contributions (NICs), there are many other potentially relevant factors, such as:
- The business
- The expected rate of growth
- The degree of commercial risk
- Administrative obligations
- Personal preferences
- Pensions and retirement
In the beginning of a business, the privacy of operating as a sole trader or partnership may seem attractive. Business funds can be used at will with fewer restrictions than in an incorporated environment.
However, we are considering here the features of a limited company. A company is a completely separate legal entity subject to two main areas of regulation – tax and company law. This planning guide looks at some of the advantages and disadvantages of trading as a limited company. Please do contact us if you want more specific help or advice.
Advantages of incorporation as a Limited Company
- Incorporation normally provides limited liability. If a shareholder has paid fully for his or her shares, he or she cannot normally be required to invest any more in the company. Although companies with bank borrowings often have to provide directors’ personal guarantees, the protection of limited liability will generally apply in respect of liabilities to other creditors.
- A company enjoys legal continuity – it can own property, sue and be sued.
- Effective ownership or part ownership of the business may be readily transferred, subject to the provisions of the Articles of Association. Whilst such transfers may well be covered by inheritance tax business property relief, the capital gains tax position needs careful review.
- A bank usually can take extra security by means of a ‘floating charge’ over the assets of the company, and this will increase the amount that can be borrowed compared with a sole trader or partnership.
- Shareholders can be paid in dividends (currently free of NICs) but strict company law formalities must be observed.
- The National Minimum Wage does not apply to directors (as they are office holders) unless they have a Contract of Employment.
- Growing businesses can re-invest profits after an overall tax charge of 20% (if profits are below £300,000), compared with 40% for higher-rate tax paying sole traders and partners.
- Accumulated funds could be withdrawn on a sale of shares with the benefit of capital gains tax (CGT) Entrepreneurs’ relief which reduces the CGT rate to 10% once shares have been held for one year.
- Corporate status is sometimes thought to add to the credibility or commercial respectability of the business.
- A company can establish an approved pension scheme, as well as private medical schemes, which may provide greater benefits than self-employed schemes.
- Employees may be offered an opportunity to buy their own stake in the business, reflecting their commitment and importance to the company.
- Formation of a company incurs legal and administrative costs, which may include new accounting records and possibly systems, new PAYE system, new business tax reference, new VAT registration, new stationery etc.
- Administrative time in informing everyone of the change of status.
- The tax position arising on the incorporation of an existing business needs careful analysis. It may be possible to defer capitals gains tax on the transfer of goodwill etc, but the timing and effect of cessation on income tax must be closely planned.
- Annual Accounts must comply with the requirements of the Companies Act 2006. In most cases, a statutory audit is not required for companies with an annual turnover of not more than £6.5 million and a balance sheet total of not more than £3.26 million. The statutory audit involves work over and above that which is normally carried out for a sole trader or partnership.
- A company’s accounts must be filed on public view with the Registrar of Companies. An Annual Return must also be submitted to the Registrar of Companies together with a filing fee of £13 (if filed online).
- The company will be taxed on its profits of each accounting period, as opposed to the income tax ‘current year’ basis for sole traders and partnerships. A company must file a company tax return.
- Funds withdrawn from a company normally give rise to tax liabilities, whereas owners of unincorporated businesses can generally introduce and withdraw cash without tax implications.
- Remuneration for directors is subject to both employee’s and employer’s National Insurance liabilities. Both the company and its directors are liable to NIC on many benefits in kind, and a P11D form may need be prepared for each director, whatever the level of earnings. This can lead to extra work in filing a tax claim for reimbursed expenses etc for which individual tax relief is available.
- Companies pay tax on capital gains at their corporation tax rate (20% for profits up to £300,000). In a company, a capital gain is reflected in the value of its shares and if these are sold a “double charge” to capital gains tax can arise. This may be avoided if assets that are likely to increase in value are owned either outside the company or within a self-administered pension scheme, or if a company is sold complete with its assets
- An individual has greater flexibility in dealing with trading losses.
- A company director is more at risk of criminal or civil penalty proceedings, eg for late filing of accounts or for breaching the insolvency rules.
Disadvantages of incorporation
It is always important to look at the long term benefits rather than short term gain. Whilst there could be increased costs in setting up a limited company, the advantage of having a trusted advisor (your accountant) could help to potentially grow the company. The accountancy fees could be swallowed up by the increases in profits. That said, the same could be said for a sole trader. A complicated Self-Assessment should be completed by your tax advisor or accountant to ensure you are correctly complying with all aspects of tax and ensure you are benefiting to your max.
All this shows is you should complete your research before jumping into one form or another. Yes, once you are established you can change your status, but with everything, there would be costs involved.
We would be happy to sit and discuss your options with you and help come up with a detailed analysis to best calculate your long term success.