Business management

Incorporation – is it right for your business?

The number of people incorporating has risen fast in recent years, primarily to cut their tax liability. But incorporation is a serious business consideration beyond the obvious tax savings.

A decade ago, there was a clear tax incentive to move from sole trader to incorporated status. But in light of the rise in the number of self-employed, the government has in recent years reduced the difference in tax benefits between the two statuses to deter those using incorporation simply to reduce their tax bill.

There remain tax advantages to incorporation, but they are fewer. Nonetheless, the question of whether to incorporate remains a valid one for many people. It’s important to consider all of the costs and implications before setting up your own company. These are some of the pros and cons.

Tax savings

Many sole traders who set up a company do so for reasons of tax efficiency. As a company you can pay yourself a salary and any profits on top will be taxed at the corporate tax rate of 19%.

On top of a salary you can pay directors dividends. Philip Hammond announced in his 2017 Spring Budget that in the 2018/19 fiscal year the tax-free dividend allowance would fall to £2,000 in a bid to “address the unfairness around director/shareholders’ tax advantage”. Anything over this amount would be taxed at between 7.5% and 38.1%, depending on an individual’s tax rate. And National Insurance contributions are not payable on dividends.

“The benefits were a lot better [before],” says Lee Murphy, who founded and runs cloud bookkeeping software company Pandle. “The government has clamped down recently but it’s still beneficial.”

There is some relief elsewhere, however. As a director of a company you can claim tax relief on business expenses as long as they are incurred wholly, exclusively and necessarily in the running of your company.

“The traditional tax advantage has somewhat disappeared,” says Elaine Clark, managing director of CheapAccounting.co.uk. “Unless you have profits over £30,000 then there’s very little tax advantage any more.”

Limiting liability

Many choose to incorporate because of the limited liability. As a sole trader, you and your business are viewed as the same legal entity so you are personally liable. With a limited company, your risk is reduced because the company is a separate legal entity.

“One of the main reasons people move to a limited company is the protection, particularly if you operate on your own or have a house,” Clark says. “I still think this is very important and shouldn’t be overlooked.”

With limited liability, if a company were to get into trouble, a director’s personal assets would be protected, but many view this advantage for the long term.

Martin Atkins, a partner at accountancy firm Menzies, adds: “Others have ambitions and want to grow a sustainable business that will support the employment of others and that they can sell or pass on to the next generation. They are happy to invest in a structure in the short term, for potential long-term gains. These individuals will view incorporation as a means of establishing the business on firm foundations, while minimising the risk of financial liabilities.”

Raising your profile

Incorporation can convey an impression of respectability and professionalism to suppliers, employees and clients. With more clearly defined structure and legal responsibilities, a company can be viewed as more dependable because more is at stake.

“There’s a perspective that a company is bigger so it adds status,” Murphy says.

Investment is likely to be easier to obtain as a limited company. However, banks may require directors to give personal guarantees, which impacts on the limited-liability advantage.

One of the main reasons people move to a limited company is the protection. I think this is very important and shouldn’t be overlooked

Elaine Clark, managing director, CheapAccounting.co.uk

If you want to sell your business, being incorporated should make it easier too. Investors and buyers tend to prefer incorporated companies, as the paperwork is typically accurate and in order.

“I was looking to scale the business in the next few years and limited liability gives me that confidence,” says Mark Hamill, who sought advice from Menzies to set up his business The Naked Headhunter in 2017. “It’s about challenging myself to be bold about what I wanted to achieve out of the business.”

Responsibilities and paperwork

Responsibilities increase significantly as a company director. As a director, you must adhere to more compliance by maintaining rigorous bookkeeping; producing statutory accounts, which must be filed at Companies House; and submitting tax returns.

It’s worth noting that fines for late payment or late returns are bigger, too.

Many people aren’t aware of what’s involved in the basics of setting up a company. With incorporation, there’s a lot more administration to do right from the start as regards straightforward things such as opening a business bank account.

Returns are more complex, with more regulatory requirements than you are subject to as a sole trader. The CS01 confirmation statement, which became effective in 2016, is another form you’ll need to complete and submit yearly.

More paperwork means greater costs too. For microbusinesses, this should be a major consideration. Accountancy fees can increase as well.

Be seen

There is also greater visibility, which can fall into both positive and negative categories depending on your view. It’s great for potential clients, who can check out your credibility because you’ll be on a public register at Companies House. Your balance sheet will be publicly available as well.

Martin Atkins says: “Weigh up the decision carefully and get professional advice. It’s important to be aware of the potential risks, particularly if opting for sole trader status.

“Regardless of whether you choose to operate as a sole trader or get incorporated, it’s important to research the target market carefully and put in place a pricing and cost structure that will be profitable. It’s also important to consider the ongoing costs and responsibilities that come with incorporation.”

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