Joseph Lawrence

Running a business takes good planning and expertise to stay ahead of the competition and keep in line with legal requirements.

At Joseph Lawrence we understand how difficult that can be and provide our professional services for all your ongoing needs.

You are obliged by law to pay taxes, and return details of your accounts at set times of the year. We can help you with any of these obligations – leaving you more time to run your business.

As your business grows you may need, from time to time, a number of extra services to help you along the way; we can advise you on the services available to you, and tailor them to suit your needs.

The Pros and Cons of Incorporation

For many years small businesses have faced the question of whether there would be a tax advantage in converting from an unincorporated sole trader or partnership to a limited company, with shareholders and directors. Over the years the “break even” point has fluctuated as rates of income tax, National Insurance (NIC) and corporation tax have changed. Up until the early 1990's an annual profit of £50,000 or more was needed to make incorporation worthwhile.

However, in recent years there have been a number of further changes in the tax system which have lowered the threshold for incorporation to the point where, on paper at least, almost every business could save tax by operating as a limited company.

Advantages of Incorporation

The main commercial advantage of running a business through a company is the limited liability status, which provides protection for the owners’ personal assets against commercial risk. Of course, this advantage may be diminished where bank finance or other sources of credit can be obtained only on giving personal guarantees. Nevertheless, for many businesses, limited liability is probably the single most important factor in deciding whether or not to operate as a company.

In some business sectors, the word “Limited” after a business name may provide enhanced status in the eyes of bankers, suppliers and potential customers and can help with winning new contracts.

On the tax side, the main benefit from operating as a company is the ability to avoid NIC on profits by paying dividends. Furthermore, the controlling director/shareholder can determine how much salary to pay and can therefore control how much Class 1 NIC is payable.

For larger, more profitable businesses with annual profits of, say, £40,000 and above, significant further tax savings can be made where the proprietor chooses to retain profits within the business for future expansion, and limits the amount of salary or dividends taken. The small company corporation tax rate of 21% (for profits up to £300,000) compares very favourably with the 40% income tax rate and NIC payable on unincorporated profits above the basic rate band.

Disadvantages of Incorporation

Having promoted the benefits of incorporating a business, it is essential not to overlook potential tax disadvantages. The importance of these will vary from one business to the next but may include:
•    A less favourable treatment of any trading losses which may arise,
•    Significant tax charges on company cars, depending on the type and price of car and the extent of business and private mileage,
•    Reduced Inheritance Tax relief for assets owned personally but used by the company, e.g. office or factory premises,
•    Potential double tax charge on the sale of the business, if the purchaser does not wish to buy the shares,
•    The possibility of future changes in tax law which may reduce or eliminate the savings altogether.

There may also be commercial reasons why running the business through a company is not a good idea. Not the least of these is the requirement to file accounts at Companies House, so that the financial results of the business are on public record. Furthermore, the accounts need to meet with rigorous disclosure requirements of the Companies Acts and if the turnover exceeds £6.5m the accounts will require an audit. This could affect small businesses with large turnovers but low margins, e.g. second-hand car dealers. In general terms, companies are faced with some additional administrative burdens which may result in increased professional fees and there will also be some initial upheaval during the transition from sole trade/partnership to the limited company, as bankers, customers, suppliers, insurers, etc need to be informed. In regulated industries there may be additional hurdles to overcome e.g. applying for new licences.

In most cases, the additional time and cost of running a company should be easily outweighed by the tax savings, but if the likelihood of tax savings is uncertain, e.g. because of fluctuating profits, incorporation may not be worthwhile.

Other Factors

If a business has recently, or is about to undertake significant investment in plant and machinery or motor vehicles, care is needed to ensure valuable capital allowances are not lost or deferred.

Knowledge based businesses need to be aware of the IR35 legislation applies to “personal service companies” and which may render the tax advantages of paying a nominal salary and substantial dividends unobtainable. There is also legislation to prevent the avoidance of tax by diverting income and profits to spouses or other members of the family and, in the light of the thousands of businesses transferring to limited companies, the Inland Revenue have recently announced their intention to apply this legislation more firmly in future. This will be of concern mainly to those businesses where there is a low capital base and/or the spouse has little or no active involvement in the business.

Finally, particular care is needed where there is the prospect that the business could be sold within the next two or three years.

Conclusion

A multitude of factors need to be taken into account in deciding whether or not to incorporate a business. Professional advice should be taken in all cases before a decision is made. Whilst it is relatively easy to get a business into a company, it is important to plan an exit strategy, in case one is needed!