A Business operating as a limited company has two main advantages over those operating as sole traders or partnerships; limited liability and generally, lower tax bills.
Recent experience has reminded us that even highly profitable businesses can be damaged beyond repair by significant changes to the economic environment. It is therefore worth considering what is at stake if your business fails.
There are many factors to consider as to which is most appropriate to your business. A limited company will usually be more tax efficient; however, there may be circumstances specific to your business that mean that this is not appropriate.
Tax Advantages of limited company
Lower overall tax liability
A company is taxable on its profits and then the shareholder/director is taxed on amounts that the company pays to them, which most commonly will be in the form of dividends. As dividends are not subject to NIC the current tax rates mean that savings can be made by incorporating a business at all profit levels. Given the costs involved we would suggest that it is worthwhile incorporating where profits are £20,000 or more.
Retain and reinvest
Since tax is only due on dividends when they are paid, further savings can be made if the profits are either not needed by the shareholders or are required for reinvestment in the business. This enables the tax payer to manage their tax charge – particularly useful for individuals facing a top tax rate of 45%.
Opportunity to capitalise goodwill
If you have an existing business there are tax reliefs that enable your business to be transferred to a company in return for shares. It is however, possible to sell assets such as goodwill to the company in return for a debt to the business owner. The gains on these assets will be taxable at a rate of 18% or 28% (Depending on the level of taxable income during the year) which may be reduced to 10% by Entrepreneurs Relief. The debt created is usually left on a loan account and can be drawn down by the business owner as required, without any further tax charge.
In summary, if you trade as a sole trader or partnership you should consider, along with an accountant, whether becoming a limited liability company should be part of your strategy to finance growth or to retain more of your profits long term.
Take David for example, he came to us as a sole trader with a profit of £50,000. By assisting him with incorporating his business, we were able to save him almost £5,000 in his first year.
If you would like to do the same, please contact us for a free consultation.