From a tax planning perspective, incorporation of a business into a limited company has long been considered the gold standard in business development and growth – but is this still the right move?
Our experienced team have explored the various benefits and disadvantages to give you a clear view of the best option for you.
Liability
The central issue around whether to incorporate your business or not is the question of liability.
A limited company is its own legal entity, separate from you or other directors. When you operate as a sole trader, in comparison, you are not legally separate from your business.
Incorporation carries several filing and registration responsibilities which aren’t required as a sole trader or owner of a partnership.
However, incorporation also means that you aren’t personally liable for business tax and debts, offering a significant amount of protection when it comes to borrowing and investment for growth.
Profit extraction
Extracting profits from a partnership or as a sole trader is straightforward. The company is not legally separate from you, therefore profits are classed as your income.
With a limited company, profits must be legally extracted from the business to be accessed for your personal use, which can be done through:
- Salary – Paying each director a salary, sometimes at the value of their Personal Allowance for tax efficiency.
- Dividends – A distribution of company profits to shareholders, taxed depending on your Income Tax band.
- Director’s loans – A way of borrowing money from your company without creating immediate personal tax liabilities.
Planning profit extraction is essential to ensure that your personal finances are as efficient as possible.
Paying tax on profits
Tax is often a strong influence in the decision to incorporate your business or not.
Limited companies may benefit from a lower overall tax liability, as they are subject to Corporation Tax on profits.
This is charged at a rate of 19 per cent for profits below £50,000 (small profits rate) and 25 per cent for profits above £250,000 (main rate).
Profits in between these thresholds are subject to a gradually increasing rate of Corporation Tax from 19 to 25 per cent.
In comparison, sole traders and business owners in a partnership must pay Income Tax on profits.
Income Tax is charged at a basic rate of 20 per cent – rising to 40 per cent for yearly income over £50,270 and 45 per cent for yearly income over £125,140.
Additionally, the Personal Allowance is reduced by £1 for every £2 that you earn over £100,000, meaning you have no Personal Allowance if you earn over £125,140.
This means that, as your business grows, incorporation could be the more tax-efficient choice.
Corporation Tax reliefs
As a sole trader or owner of a partnership, you can claim certain running costs, such as office costs, staff costs and travel expenses, as allowable expenses.
These reduce your taxable profits and overall tax liability.
However, as your business grows, you may be able to become more tax-efficient by incorporating and benefitting from Corporation Tax relief, including:
- Capital allowances – Writing off plant and machinery costs against taxable profits
- R&D tax relief – Credit against qualifying spend on R&D costs
- Structures and buildings allowance – Writing off some construction costs for commercial buildings
- Patent Box – Lower Corporation Tax rate of 10 per cent for earnings from patented inventions.
These reliefs are only beneficial over allowable expenses if you make sufficient capital expenditure.
The drawbacks of incorporation
Each company structure has its challenges as well as its benefits.
As a separate entity from its owners, a limited company carries filing requirements with Companies House and additional responsibilities for directors in the form of Director’s Duties.
March 2024 saw the introduction of higher Companies House fees for certain filing requirements, including filing a confirmation statement, incorporation and changing the name of your business.
New regulations were also introduced, including:
- Explicitly confirming that the company exists for lawful purposes
- Greater powers for Companies House to query discrepancies
- Requirements for identity verification for UK business directors
- Requiring a registered email address when submitting a confirmation statement
If you choose to incorporate, you must ensure that the company directors have the willingness and capacity to take on these tasks and meet filing deadlines on a regular basis.
Additionally, the tax benefit of incorporation for directors may be decreasing as the dividend tax-free allowance falls.
We can advise you on the right structure for your business and how to manage the challenges that accompany it, including how to navigate tax liabilities, filing responsibilities and profit extraction.
Contact a member of our team today to discuss how we can help you.
