To Incorporate or Not To Incorporate...that is the question!

It is important when you startup your business to consider the entity through which you should trade. Should you operate as a:

• Sole trader – an individual
• Partnership – two or more individuals or companies
• Limited Liability Partnership
• Limited Company

It is equally important throughout the life of your business to every so often step back and ask yourself if the entity you are using is still the best option for you to use. Should you consider changing?

As accountants we are often asked whether or not our clients should form limited companies and the answer is not an easy one. There are several factors that need to be considered in order to try and make the decision to incorporate such as: -

• Type of business
• Administrative obligations
• Degree of commercial risk
• Profitability
• Expected rate of growth
• If there are existing losses to be utilised
• Personal preference

There are however several advantages and disadvantages of incorporating which should be taken into account.

Advantages

• A company is a separate legal entity. It can own property in its own name, sue and be sued.
• Companies provide their owners, the shareholders, with the protection of limited liability in respect of creditors as opposed to sole traders whose personal assets are always at risk. That said, directors’ personal guarantees are usually required for any bank borrowings in which case the potential risk still applies.
• Larger organisations quite often will prefer not to deal with unincorporated entities so sometimes you can be left with no alternative but to incorporate.
• Companies may be given greater borrowing potential as they can use their assets as security.
• Shareholders can be paid in dividends which are subject to different rates of income tax and are not currently subject to national insurance.
• The corporation tax rate is currently 20% for profits up to £300,000 whereas the tax rate for sole traders increases to 40% at £41,450 and to 45% for profits over £150,000.
• Effective ownership of the business can be readily transferred subject to the Articles of Association.
• External investors can be encouraged to invest in the company via tax breaks available through using the Enterprise Investment Scheme or Sees Enterprise Investment Scheme.
• Accumulated funds can be withdrawn on the sale of the company with the benefit of Entrepreneurs Relief whereby the first £10million of capital gain is charged at a rate of 10%.
• A company can establish a registered pension scheme which may provide greater benefits than self employed schemes.
• Employees may be incentivised by being offered to buy their own stake in the company (with adequate safeguards) to reflect their commitment to the company.

Disadvantages

• The administrative burden is much more for a limited company. A company must keep enhanced accounting records, file accounts and annuals returns with Companies House (subject to an online fee of £13) and keep statutory books. This is a very important factor to accept as we have seen many examples of owners switching back to becoming sole traders as they cannot cope with the company expenses being kept entirely separate from their own.
• The formation of the company itself can incur legal and administrative costs such as the setting up of new PAYE systems, new VAT registration, new stationery etc.
• Accounts filed at Companies House are on public record. You are allowed to file abbreviated accounts so what is disclosed is quite restricted. Any reader though will be able to identify the directors of the company. You can however use a service address (which could be our own) so as not to disclose your home address.
• There is a lot less flexibility with the use of trading losses for a company. It is therefore important that any losses built up in the sole trader business are fully utilised before the business is incorporated.
• There are both employees and employers national insurance payable on directors remuneration which combined total 25.8% for those who earn over £646 per month. However as previously mentioned this does not apply to dividends drawn from the company. Sole traders pay what is called Class 4 national insurance of 9% on the profits over £7,755 up to a limit of £41,450 and 2% on profits above this limit. By paying this additional liability there is no increase in social security benefits should there ever need to be a claim.
• Both the company and its employees will be subject to national insurance on any benefits provided by the company which must be reported annually on a form P11D. This includes things such as company cars, fuel provided for private use, company vans, private medical insurance, loans, to name just a few.

If this article has given you reason to consider changing the way you operate your business then we would be pleased to discuss your current and future circumstances in order to help you draw the correct conclusions about how to run your business.


For further information please contact Anthony Brice or Rachael Mabbott via our social media or on 01234 301000.