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Disadvantages of Incorporation including Practical Issues

Disadvantages of Incorporation including...

It is easy for sole traders  to be persuaded to incorporate for the headline tax reductions and the advantage of limited liability. However,to give the full picture, I am trying to gather a full list of issues to be considered against this. Any help with this would be appreciated. I have made an initial list which follows. Please feel free to correct me or add anything else.  I am particularly interested in the practical issues as increases in costs have been quite substantial for some businesses.

  1. Annual accounts have to be filed at Companies House and are available for public inspection as is other information about the company.
  2. Formal meetings and minutes need to be kept on decisions to help protect the directors from personal liability.
  3. Directors are personally subject to regulations and can be fined or found guilty of a criminal offence for failing to comply.
  4. Far more compliance and regulation to deal with increasing the risk of penalties.
  5. A company is more complicated and costly to wind up.
  6. Generally involves higher accountancy fees for accounts alone.
  7. The question of IR35 must be seriously considered. If it is found to be in apply then there is likely to be more total tax paid through the company than there would have been as a sole trader.
  8. Additional accountancy costs in dealing with compliance and returns for company secretarial matters, payroll, P11ds, interim accounts to justify dividend payments.
  9. Higher costs for preparation of corporation tax returns and iXBRL tagging versus personal tax return.
  10. Any losses made by the company cannot be used against the owner's other income.
  11. The possibility that mortgage lenders will ignore dividend income.
  12. Company cars become liable to personal company car  tax and employers NI or if approved mileage rates are used to avoid this, it is often the case that the full costs of business mileage are not allowed. This is a particular problem with high emission expensive cars.
  13. Professional Valuation costs are incurred regarding goodwill if this exists and is being transferred to the company.
  14. Where the sole trader without employees incorporates, as an employer the company has new costs for employers liability insurance and compliance with health & safety regulations.
  15. There are practical problems in changing existing contracts over to the company name. I have seen instances where a company van insurance nearly doubled because of incorporation – same van, same drivers. Also instances where costs of services have increased because the company is a “new customer” with no entitlement to discounts previously agreed with the sole trader. Failure to change contracts to the company name can have tax implications such as the benefit in kind charge for a mobile phone still in the name of the director.
  16. Surplus funds in the business can be used by a sole trader without tax implication(except potential reduction of allowance for bank interest if there is an overdraft). This is not so easy or tax effective in a company as the company will pay a tax charge of 25% on any loans from the company and the director will pay tax on beneficial loan interest if no interest is paid. There is also the duty as director to consider the needs of the company before taking a loan.

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20th Mar 2012 19:25

And another thing.....

In my experience, I'd certainly add "client education" and error rectification.  Sole tradership to incorporation is a lot for them to cope with and they tend to be creatures of habit, and it can take a few years to change their ways. 

All in all I find your list very good reading, well done.  And also a bit scary when summarised like that.

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20th Mar 2012 19:43

Problems with SDLT liability under s53 FA 2003 when transferring property.

Relief available on trf from partnership to company under Sched 15, but HMRC can overturn this by invoking anti avoidance provisions.

If property is left out and a rent charged following occupation under licence, then the rent will mess up the entrepreneurs relief claim

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By Old Greying Accountant
20th Mar 2012 21:23

So why not ...

... LLP - best of both worlds?

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Arm266
20th Mar 2012 23:38

No SCR

True, but the idea for the limited company may be driven by a wish to retain profits after charge at the small companie rate.

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21st Mar 2012 00:02

The wholly, exclusively and necessarily rule often causes problems for the deductibility of expenditure in some areas.

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21st Mar 2012 10:19

Small Points

But in point 8 I think the reference to payroll & P11Ds should come out as incorporation doesn't really impact these?  A sole trader can also employ people and have to go through the same processes, unless it's in relation to a sole trader with no employees so just employing the director (in which case it would perhaps sit better in point 14)?

Also, on point 2, I believe private Ltd companies are no longer required to hold meetings?

 

Interesting reading though, thanks, as I'm going through that process at the moment!

 

Cheers

Pat

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28th Mar 2012 10:54

The bigger it gets

Interesting analysis

Generally once the business starts to grow the argument for incorporation grows.  It is really quite risky to be trading as a sole trader if turnover is hundred of thousands.  Yes we do see it and if the business fails then it is really messy...

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28th Mar 2012 11:07

Only touched on the two biggest issues

I think two of the biggest issues you have hardly touched on.

 

Fist one is private motoring. What type of car(s) does the owner operate, and how will the various ways of getting relief for motoring impact his tax situation.

 

The second is the little items where contracts exist and will take time to shift over to the company: eg broadband, mobile phone, home telephone. I am sure there are other examples. To avoid tax/NIC issues these should be in the company name. The providers may well increase their charges.

 

Also things like liability insurances have a tendency to cost more.

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28th Mar 2012 11:08

To add to OGA

How about an LLP and a LTd Co as a partner.  Run the LLP as a business, extract profits via Ltd Co partner.

Whilst the list is extensive I am sure a list of why not be self-employed would be long too.  

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28th Mar 2012 11:11

llp and company

Further up the income scale an llp with a corporate member has merits.

I think some of the benefits are being short sold here and many of the extras are the one (wo)man business, no employees, incorporation v sole trade.  As soon as you have an employee either way you have payroll, HR and HS issues.

My experience of higher charges for CT returns is largely that CT tax staff carry a premium over personal tax staff.

If you are active (I loath proactive) with your client, you are identifying these issues and providing the solutions either in-house or recommending buy in services.  As long as the price is right, you become more than a year end number cruncher and an essential part of the business.

Assuming dividends replace profits, NI savings can be made.  Businesses that have irregular cash flow can smooth tax costs to avoid feasting and famine.

With a sensible approach there can be some balancing of spousal income with some joint shareholding.

 

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By DMGbus
28th Mar 2012 13:49

Surplus funds + iXBRL + RTI + CIS + Funding (CT61 issue)

Surplus funds is mentioned in the OP.

Increasingly I see issues where Ltd Co money on deposit seems to earn only 0.5% or 1.0% interest, when on similar notice terms 3% or more can be earned for deposits in individuals names.

With a sole trader easy - withdraw the money and invest it as an individual at 3%.  With a Ltd Co serious tax problems if this is done.

Can happen with investments in general - a Ltd Co client I have [L105] once followed HSBC's investment advice and £250k was withdrawn and invested in  personally owned investments (including premium bonds) - creating an overdawn directors loan account and potential s419 tax liability of some £62,500.  Fortunately it came to my notice before the annual accounts were drawn up and things were sorted out by the financial year end (apart from beneficial loan interest).   No such issues with sole traders.

With regard to bank deposits I've not seen a clear cut straight-speaking answer on depositer protection as it applies to Ltd Cos.  Seems clear for individuals but, when I last looked it up the rules were very well (ie. successfully) hidden for Ltd Cos.

Then thanks to that hidden Office for Tax Complication undercurrent within HMRC we have two serious burdens placed on small businsses that are Ltd Cos...

# iXBRL - increasing costs (more complicated CT600 filing)

and

# RTI - for a sole trader not necessary if no employees, but RTI  (Real Time Information) filing becomes an added burden for a Ltd Co if any directors remuneration is drawn.

The common factor with iXBRL and RTI is added time and cost burdens for small business where HMRC can get away with it because no-one effectively lobbies on behalf of very small businesses as those who could / should / are in the know on these matters will financially benefit from these new burdens at the expense of small business.

A business with no employees as a sole trader and who is not VAT registered has one tax return a year - an SA return.

As a Ltd Co we "gain" a CT600+iXBRL computations plus 12 RTI reports a year for monthly salary drawn , and still have an SA return ibn most cases for the director.   So one report a year as a sole trader is exchanged for 14 tax reports a year through having a Ltd Co.  If there's a low (or no) directors loan account balance and the director likes to draw money weekly strictly there'll be 52 (fifty-two) RTI reports a year required rather than 12!

CIS (Construction Industry Scheme) - I keep reading plenty of reports about delays getting surplus CIS deductions refunded via P35 process for Ltd Cos - and I had one such client myself (eventually sorted got the money back TWICE from HMRC in my client's case, so cheque had to be sent to HMRC to put this right!).  Not seen any issues with sole trader CIS clients getting CIS tax refunded via their SA returns in recent years.   HMRC "are on the case" on this issue - it now transpires why the problems have arisen - centralisation of functtions - in this case P35 at one HMRC office combined with these matters being dealt with by an HMRC office that for several decades has been, in my 37 years experience, accustomed to getting away with delays in dealing with matters.   Whilst HMRC will not acknowledge the cause of the problem they have at long last under pressure from Working Together started to (claim to) be doing something about the problem.

Funding the business - I currently have the case where company borrowing was going to cost a lending fee of some £15,000.  Sorted - don't borrow in company's name, borrow personally (no lending fee of £15,000 instead a more modest fee, probably less than £1,000) based on personal mortgage advance. OK - £14,000 of Bank rip-off fees saved, but how to get tax relief on the loan.  Unfortunately involves an extra tax return and tax cashflow - the CT61 return!

 

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28th Mar 2012 14:09

main points I use
Better record keeping needed - eg seperate company bank that is reconciled etcHigher accy fees - funny most clients don't mind thisLimited Liability - the single biggest point I stress to people which is why OGAs mention of LLP is worth consideringcar/van costs -  a dealbreaker where the owner is a petrol head!

On balance I have found clients do tend to incorporate as they see the headline tax savings, and potential of even greater savings if shares can be gifted to spouses who have lower income and there is no settlements issue. But I always leave the decision to the client and they have to reply to my balanced arguments and decide themselves

Main thing is I always treat each case individually and advise someone just because their mate said they should incorporate.

As far as the winding up a company stage I do explain it to people but they never want to hear as thet is an early admission that it may not work and they will have to go and get a job!

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28th Mar 2012 14:47

Anticipated tax savings can be illusory

1 - Headline projected tax savings on profit figures rarely recognise the differences in the way that tax adjsuted profits will be computed - eg: private use adjustments and BIKs.

2 - As tax rates and allowances change each year the savaings will vary

3 - Income tax will still be payable (often for some long time) on pre-incorporation profits even after company starts trading.

4 - Corporation tax (and PAYE) then become additional taxes to budget and pay until IT is no longer payable

Client's perception may well be that the promised tax savings were a con.

Mark

 

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28th Mar 2012 18:05

Insurances

I don' think a company needs employers' liability insurance if it only has a single director/shareholder and no employees.

It will need public liability insurance.

Hope this helps.

Malcolm

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28th Mar 2012 18:28

... and something else to bear in mind ...

Nobody can guarantee that the current tax regime will continue. It has changed many times and the advice I give has changed a lot over the last few years.

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28th Mar 2012 19:41

@Shirley - Great Point

Maybe us accountants should take that on board and in the tone of (say) an stockbroker we should state "that tax can go down as well as up" and so our advice is only based on ligislation as at todays date and known changes"

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By Old Greying Accountant
29th Mar 2012 12:34

Sole trade, in its pure form ...

... needs to be seperated from a single owner business.

A pure sole trader is just that, one person trading, and many, especially if they are trading as a "trade" (builder, plumber, decorator etc) are not suited to incorporation, and the tax savings negligible. Most of the main debts/risks that limited liability seeks to address would in these circumstances likely be covered by personal guarantee anyway!

An unincorporated business with a single owner, but many staff, possibly many branches etc etc is a different kettle of fish, and as said by many above each instance needs to be looked at on its merits.

I agree particularly with Bookmarklee about dodgy representation, so many dividend/salary/sole trade comparissions are so deeply flawed it is not even apples and pears, more like apples and pianos being compared! The only ones that work are those that show how the owner will end up with a given net amount, not those that show the effect of taking a given gross amount, although with the MCR for Tesco coming down to virtually the same as Joe Bloggs Limited corner shop this must improve.

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31st Mar 2012 19:56

public liability insurance

I don't think any business is required by law to have public liability insurance? I thought the only compulsory insurances were 3rd party motor and employer's liability.

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01st Apr 2012 07:28

I don't think that ...

... item 13 is valid.  Certainly there is a cost in obtaining goodwill valuations (where appropriate), but that cost can be ring-fenced against the tax benefit of capitalising the goodwill, which will I think generally outweigh that cost.  If it does not, then you would not bother to sell the goodwill to the company.

With kind regards

Clint Westwood

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By Lesley5
26th Mar 2013 11:39

Disadvantage of incorporation

If it is the type of business that has stock and/or accrued income (WIP) and is below the VAT threshold then the new rules on cash accounting could advance the tax cost of operating thru a limited company versus  sole trader as sole trader will be able to be taxed on a cash basis rather than an accruals basis as a limited co.

Lesley

 

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