To incorporate or not to incorporate, that is the question! More frequently it seems….

By Katie Taylor – Business and Tax Adviser.

With online incorporations and filings, incorporating a business is becoming easier and easier. Conversely, with the constantly changing dividend rules coming into effect, the gap between limited companies and sole traders/ partnership is closing significantly.

Due to these changes, whether or not small businesses or partnerships should trade via a limited company is a question we are seeing being asked more and more frequently.

Unfortunately there is no one answer fits all and so below, I have sought to highlight some of the considerations a business owner should contemplate before incorporating.

1. The numbers

Whilst this seems pretty obvious, it really is one of the main reasons for incorporating. Sole traders and partners in a partnership, are assessable to income tax personally on everything they earn at tax rates of up to 45%.

Shareholders on the other hand, (whilst the company itself would be assessable to corporation tax at 19%), would only be subject to income tax on money they withdraw from the company by way of either salary or dividends.

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As such, if reinvestment is a high on the priority list and cash extraction is less important, then incorporation might be a more attractive route. If not, there could be double taxation; both in the company and in the hands of the business owner upon extraction.

2. Tax consequences

A transfer of assets from a sole trade or partnership into a company, would effectively be a disposal and reacquisition for tax purposes. As such, this could create a large tax liability in the hands of the individual incorporating their business.

Whilst incorporation relief can be applied to partnerships, for sole traders with significant assets, a large tax bill could arise upon incorporation and so timing and careful consideration is essential at this point.

3. On-going compliance

As a company is a separate legal entity to the business owner, it is required to submit its own tax return, along with a set of annual accounts and compliance statement each year. These two together can be quite costly and is a cost a small business would generally not incur.

Failure to adhere to these filing requirements can also lead to significant penalties and charges and so these additional costs need to be considered upfront. Company requirements can be found here via Gov.uk.

4. Legal changes

One of the main reason for incorporating a business is due to the legal differences between the two.

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A sole trade and certain partnerships are not deemed to be separate legal entities from their business owners; as such, if a business runs into financial or legal difficulties, then the owners will be held solely responsible for these issues.

However, this is not generally the case in a company, as a separate legal entity, the owners are protected (to a certain degree) and the company itself, will be held accountable for any issues it may face. Further information regarding the legal benefits can be found in the Law Gazette’s article.

The above is not an exhaustive list but merely seeks to highlight just some of the areas that should be considered before deciding to incorporate.

Upon incorporation

If a decision is made to incorporate, then you still have to consider whether or not to pay yourself both a salary and/ or dividends out of the company. The answer to this will depend on various factors such as cash in the company, cash due to be reinvested and the tax circumstances of the shareholders.

More often than not, even with the proposed changes, paying a small salary of circa £8,000-£10,000 and the remainder as a dividend is generally the most tax efficient way of extracting cash from a company.

However, as always with tax, there is no one rule fits all and so if you’d like us to run the numbers of your company, to find the most tax efficient cash extraction method, please get in touch with one of our tax team members on 01202 717867 who would be more than happy to assist.

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