02 February 2018
There comes a stage in the life of many sole traders and partnerships when the incorporation question arises, but the decision is rarely straightforward. Here we outline the benefits and disadvantages of trading as a limited company.
The law treats a limited company as a separate person, distinct from its shareholders and directors. So, the shareholders of a limited company are liable only for the value they gave for their shares. Their personal assets are not normally at risk, unlike those of a sole trader or partner.
There are some exceptions to this rule; directors’ personal assets can be in jeopardy in cases of fraud or wrongful trading, or to honour any personal guarantees.
A company can normally raise more finance than a partnership or sole trader because it may give a floating charge over its assets. This is particularly useful where debtors or stock form a significant proportion of the business assets. However, lenders often ask for personal guarantees.
Limited liability companies are required to:
- Prepare statutory accounts in accordance with the Companies Act. These are more detailed and costly to prepare than partnership or sole trader accounts.
- File information with the Companies Registrar giving details of directors and shareholders.
- File accounts with the Companies Registrar for public inspection.
Deadlines for filing accounts with the Companies Registrar are strictly enforced with fines for late submission.
Some companies are obliged to:
- Hold formal board meetings and an Annual General Meeting.
- Have an annual audit carried out by a registered auditor.
The rate of Corporation Tax on company profits is 19%, whereas the top rate tax on individuals is 45%. To the extent that profits are not drawn by the proprietors, a significant saving may be obtained. This is therefore of benefit for a growing company that needs to leave profits in the business to finance increasing levels of debtors and stock.
There are however tax disadvantages. All monies drawn by the directors must be subject to PAYE and NIC or paid as dividends. This contrasts with unincorporated businesses in which the proprietors’ ability to draw funds for personal use is subject only to commercial and cashflow considerations. Directors are permitted to borrow money from the company, although the company would suffer tax at 25% of the amount borrowed as a consequence. In certain circumstances, the individual directors may also face an Income Tax charge if the loans are interest-free. Cars owned by the company and used by the directors give rise to charges for Income Tax on the directors and NIC on the company.
Disposing of an interest in the business or inviting others to participate
The easiest way to sell a company is to dispose of the shares to a third party, generally a simpler transaction than selling an unincorporated business. In the right circumstances a retiring director/shareholder can sell his shares back to the company, using the company’s money to pay him or her out.
Should you wish to invite an employee or associate to take a share in the business, this is simpler with a limited company as shares may be transferred or issued to the percentage required. (Beware of tax traps, however, when issuing shares to employees.)
It is essential that detailed planning is carried out before incorporating a business. Increased tax liabilities may be incurred by the cessation of the old business, and avoidable Capital Gains Tax, Income Tax or Stamp Duty costs may result from poor planning. Also, a properly executed incorporation may afford a unique opportunity to withdraw cash or assets from the business.
For further information about this topic, please speak to one of our accountants in Newcastle, Jarrow or Sunderland.
As one of the leading firms of accountants in the North East, with offices in Newcastle, Sunderland and Jarrow, we have the expertise to advise you on a wide range of tax related issues. If you would like to speak to one of our local experts, please contact us.