Incorporation - why bother?

If you are sad enough to study the HMRC ‘Rates and Allowances’ archive and compare tax rates it is noticeable how the ‘break even’ point for incorporation has fluctuated over the years such that, until relatively recently incorporation was only beneficial if the annual profit exceeded £50,000, reports Jennifer Adams.

Now as corporation tax rates are significantly lower than income tax rates all businesses need to consider incorporation whatever the profit but as the previous article (Post Incorporation: get the details right) detailed incorporation is not easy. So apart from saving money are there any other benefits to incorporation and what are the practical issues that a business needs to consider before taking the plunge?

Benefits

Reduction in tax bill - this article does not intend to cover the calculation but a table of potential tax savings on incorporation for 2011/2012 can be found in Rebecca Bennyworth’s article at Tax Adviser.

Practical issues

  • Be careful to calculate best date for cessation of self-employment - choosing the wrong date may increase tax liability for the final year.
  • Care is needed where there is the prospect of the shares being transferred or disposed of within two years of incorporation (Business Property Relief)
  • IR 35 ‘personal service’ legislation issues for ‘knowledge based’ businesses.

Further reading

Jennifer Adams FCIS TEP ATT is a freelance writer and author specialising in tax and company secretarial issues. She can be contacted at Abacus Business Solutions. The information contained in this article is intended to provide for general educational use and information only. It is not intended to advise or recommend any particular course of action or opinion. The reader should not act or rely on any information contained therein without seeking independent legal advice.

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Comments

Incorporation

robbieb666 | | Permalink

One of the main issues I have encountered is that many sole traders/partners are just not the right type of people to run a limited company. They continue to treat monies as their own rather than the limited companies no matter how many times you tell them not to do this!!!

 

Errors

bduncan | | Permalink

There are several errors above. One for starters is:

Different categories of shares can enable different levels of payment to be allocated; advantage being taken of the different personal tax circumstances of individual directors.  - Directors do not receive dividends shareholders do.

jon_griffey's picture

Don't touch with a bargepole

jon_griffey | | Permalink

I quite agree with robbie. There are some clients - quite a lot actually who should not be allowed anywhere near a limited company. To my mind if you are to trade as a company then you must do it properly - proper books, minuted dividends, appropriate expenses, dispensations. I know there are firms out there that incorporate virtually all clients - they must recklessly disregard the formalities.

Agreed

robbieb666 | | Permalink

I agree Jon - i know firms - mainly smaller firms that have incorporated virtually all their clients but have not given them any guidance at all.

Some of the advice out there is shocking!!!

 

AnnaKournikovasKnickers's picture

Incorporation pros & cons

AnnaKournikovas... | | Permalink

As an IFA, I would make two points;Firstly, a SSAS pension has advantages over SIPPS and as you are aware, business owners  can have a SIPP but unless they are controlling directors  they cannot have a SSAS.

 

Secondly, I have just been instructed to incorporate a rugby club (I shall do so as a CIC, obviously) as the English RFU have memo'd their members (apparently*) to this effect. So there would appear to be other extraneous non accounting reasons for incorporation not covered in this article.

*P.S. If anyone knows why I would be interested to know but, hey, I'm not going to argue.

Incorporation of Rugby Clubs

grooney | | Permalink

This is all to do with limiting the exposure of members to risk.  As a members club the individual members are all collectively in the frame if, for example, someone sues the club for injury on their premises.  

In recent years some clubs have faced massive financial claims which would wipe them out and then take a chunk out of the member's personal assets too.

The RFU are advising members clubs to incorporate (limited by Guarantee) to reduce the risk to individual members and their personal assets.

 

Incorporation why bother - Pratical issues

joereid | | Permalink

Can you develop the point about being careful to calculate the best date for cessation of self-employment, as choosing the wrong date may increase tax liability for the final year.

John Stokdyk's picture

"Shareholders" amended in text

John Stokdyk | | Permalink

The article has been adjusted as you suggested, bduncan. Jennifer wrote the piece from the perspective of a sole trader who was thinking about going the incorporation route, and made the assumption she was dealing with director/shareholders.

If you could elaborate any of the other mistakes you mentioned in your comment, we will examine them with the author to ensure the article is accurate.

@joereid - you raise an interesting point about the cessation date, Jennifer has her hands full with a handful of other articles I've asked her to do aside from brief comments here, she may not be able to follow up with a more detailed examination of the tax issues. But I'll put it on our list to see if we can get someone else to do a quick digest.

However, if you click the Incorporation tag, you should find a pretty comprehensive collection of both Any Answers threads and technical articles discussing the issue in more detail. Or you can search for "incorporation cessation date" , which produces a few relevant conversations.

Thanks for the prod - I'll put it on our list and see if we can get someone to do a quick digest.

 

 

RebeccaBenneyworth's picture

Careful thought

RebeccaBenneyworth | | Permalink

Jennifer's article does emphasise that craeful thought is needed. To confirm the above comments, my acid test is the phrase "What do you mean, it's not my money?" If that is the sort of thing your client would say then you are buying a whole box of trouble. Similarly, clients who think a whole year's worth of records fit on one side of A4 are not a good bet for limited company status. I learned the hard way with a couple of clients many years ago, and I now reckon I have a good "nose" for those who should stay away from it!

One barrier to incorporation I might mention. If the unincorporated business is into the bank for a lot, you may find that moving that borrowing to a limited company entity will not actually be possible, even with director personal guarantees and second charge on the house. In some cases the bank just says no.

jon_griffey's picture

Cessation date

jon_griffey | | Permalink

joereid - this I expect refers to the issue of overlap profits etc. If you have a client with an accounting date other than 5 April/31 March then you have an issue. The worst one is usually 30 April year end. If you are not careful and pick the date of cessation late in the tax year, say 31 March 2011 then the final year's self-assessment (2010/11) will be based on the year ended 30 April 2010 + 11 months to 31 March 2011 LESS overlap relief. Often overlap relief is minimal and so the client gets taxed on 23 months of profit - maybe at 50%. And you told them that going ltd would save them tax! In this situation it would be better to choose a cessation date early in the tax year, say 30 April 2011.

John Stokdyk's picture

Thanks for coming to our rescue!

John Stokdyk | | Permalink

Much appreciated, Jon.

I still reckon there's an article in the subject, but you've managed to do a pretty good summary in one paragraph.

Cessation Date

joereid | | Permalink

Jon,

Many thanks for your comments.

RebeccaBenneyworth's picture

Overlap - my pet hate

RebeccaBenneyworth | | Permalink

Possibly even worse is incorporating a client who has reduced profits since he started. So a 30 April accounting date client who had profits of £120,000 in year 1, and has £40,000 now could have a loss due to overlap relief of around £70,000 on cessation as the profits of the final year are not big enough to soak up all of the overlap. Terminal loss releif might help but it's another case of watch out. In this case cessation on 31 March, bringing 23 months profits into the final period might help a bit.

member clubs- unaware of potential liabilty

twickers | | Permalink

you should expand on this brief article /a longer one would possibly help those who sign up as members of everything from social club to political associations without understanding the extent of liability you have referred to/even less when proudly they accept appointment to management ? of what they
are legally undertaking. ( I tried with local associations (mistake the wife was chairman of one of them)
The tax implications including CGT are rarely understood.

twickers

Incorporation - why bother

ianmckechnie | | Permalink

I'd like to see the calculation underlying the statement that the break-even for incorporation is £ 50,000.  Unless an extortionate accountancy bill is factored in, I think the figure is quite a bit lower..........

Nichola Ross Martin's picture

Just to add:

Nichola Ross Martin | | Permalink

Limited liability: the corporate veil is notoriously difficult to pierce, so you can trade comfortable in the knowledge that you can mis-sell your credentials and still escape your creditors (see checkout Williams v Natural Life Healthfoods to see how the court will resist piercing).

I say keep it simple, so you will really want to avoid the following:

Different categories of shares: best avoided unless you fully understand the consequences, as "there be dragons and you might get burnt". Beware of coming unstuck see HMRC examples in Form 42 guidance, and the wide definition of earnings in the NICs rules and don't overlook what happens when your shareholders all have different shares and fall out and you have not put in some suitable provisions to deal with this in your articles, and of course the settlement provisions.

Dividend waivers: more dragons...this time mainly the settlement provisions, but in many cases the plan goes badly wrong with folk trying to back date waivers (fraudulent activities?) or they simply fail to execute them property.

IHT planning: watch out for death! No market value uplift for property held in a company, bad result for outstanding directors loans, and of course only 50% BPA for property rented to the business.

Transfer of a trading loss - generally not recommended to incorporate if you are making losses from an insolvency angle as it this potentially puts directors in a very compromised position from day 1.

Virtual tax support for accountants: www.rossmartin.co.uk

 

Flying Scotsman's picture

Incorporation

Flying Scotsman | | Permalink

As a company formation agent I find that there is one argument that sways it for many people . Simply put , it could be the best insurance policy you ever take out. 

We live in an ever increasingly litigous society and a claimant will take aim at the easiest target. Sole trader with a home , saving and investments ?  - sitting duck. Corporate veil in the way is like a suit of armour.

 

 

 

 

Cars, cars, cars

Vaughan Blake | | Permalink

This area often swings the decision away from a ltd company.

Take a "management consultant" with a £50K profit.  Then crunch the incorp numbers and see the tax saving.  Then work out how with a company  he is going to fund his Jaguar XKR list price £60K and bought second hand for £30k.  Business use 25k miles being 95% (uses his Porsche Coxster at the weekends)

Then deduct the extra cost this, plus extra accountancy from the tax saving.  Still worthwhile?  Then consider incorporation.

jon_griffey's picture

Expensive cars

jon_griffey | | Permalink

Vaughan makes a very important point. If the client likes expensive cars, especially second hand ones then a ltd co makes it very inefficient. You get the double whammy of high benefit in kind and a 10% pool. An increasingly interesting vehicle is the LLP. As well as limited liability, it is great for avoiding the company car and 10% pool (i.e. 10% pool not so painful with private use and balancing adjustment) and drawings are much more flexible than with a company. Ideal for many clients. When our firim incorporated we found it much more appealing to go LLP rather than Ltd.

John Stokdyk's picture

Something for the car fans...

John Stokdyk | | Permalink

Thanks for your comments Jon and Vaughn, and it's interesting to note the influence your taste in vehicles can have on the incorporation debate!

Just so you know, as part of our relauch this week, we're planning to extend the number of discussiong groups, including one for those interested in cars and company cars. I hope you have time to join us there to share your insights!

Malcolm Veall's picture

Small Co.s just don't have cars in them

Malcolm Veall | | Permalink

John,

The last thing I would want to do is pour cold water on a new initiative but...

Most of us small practice GPs would not join a cars group if our client base is largely Ltd companies - because the existing car tax regime means that our clients just don't have cars in their small companies at all.  Consequently the group is certain to be of interest only to accountants advising large companies on employee/director reward packages.

why don't people look at Limited liability partnership?

mrclarky | | Permalink

Agree with all the comments about dragons and Alphabet shares and the practical aspects but for a number of clients worried about limited liability consider LLPs

  • Transparent
  • All members get entrepreneurs relief not just 5% shareholders
  • No nasty employee share issues
  • Single layer of tax on sale and acquirer gets assets rebased
  • NIC savings on cars etc not to be sneezed at

My view is that an awful lot of businesses would be better trading in a LLP then in a company.

  •