There are currently over 2.7 million limited companies incorporated in the UK. Incorporation is often preferred to a sole trader or partnership structure for one or more of the following reasons:
1. It’s quick and easy to get started
It’s now very easy to start a limited company and it can all be done on-line. Long gone are the days of waiting weeks for Companies House to process the paperwork: now you can start a limited company in just a few hours. What’s more, the cost of incorporating is an allowable expense against corporation tax.
The Companies Act 2006, fully effective from 1 October 2009, made a number of changes making it easier to run a limited company. In the ongoing quest to promote enterprise, the government continues to examine ways to give well run companies the freedom to get on with business rather than administrative formalities.
2. The company has a separate legal identity
A limited company has its own legal identity. So third parties contract with the ‘company’ and not the individual directors and shareholders. This means companies survive the death of the owners and it’s possible for the directors and shareholders involved with the company to change over time. A company’s existence will only cease if it is formally wound up, liquidated or by other order of the courts or Registrar of Companies. Amongst other benefits, this can provide more perceived security for employees than other business structures.
3. The owners’ liability is limited
The shareholders of a company have a limited or capped liability for the debts of the business. The extent of their liability is the amount paid for their shares plus, if they have any, the unpaid amount on any nil or partly paid shares. In practice it is usually just the amount paid for the shares plus any unsecured loans made to the company.
This limit on the shareholders’ liability contrasts with the situation for partnerships and sole traders where there is potentially unlimited personal liability (e.g. your private residence at risk) for the debts of the business. A limited company can therefore allow you to take a calculated business risk without the prospect of losing everything. If the shareholder is also a director of the company then the limit on their liability does not always apply. Indeed, if creditors lose money through director fraud, the directors’ personal liability is unlimited.
4. Potential credibility and prestige
The formation of a private limited company can suggest that the business has permanence and is committed to effective and responsible management. It gives both suppliers and customers a sense of confidence and many companies, particularly larger businesses, will not deal with an entity that’s not a limited company. Incorporating a business can therefore open up new business opportunities that wouldn’t otherwise be available.
Sole traders and partnerships will not necessarily have a unique name, whereas there can only ever be one active UK company with any particular name. Once you’ve registered a company with Companies House, your new company name is protected and no-one can use the same name or even a name that’s too similar.
5. There can be tax benefits
Sole traders and partners in a partnership pay income tax while companies pay corporation tax. While corporation tax rates are lower than income tax rates the advantage may lie with incorporation.
As well as salary payments to employees, a company can also pay dividends to its shareholders. A shareholder director will therefore often choose to receive the most tax efficient mix of salary and dividends. Provided a minimum level of salary is taken, the director retains entitlement to certain State benefits without any employee or employer National Insurance Contributions being payable. The balance of remuneration is taken as dividends, which tend to be suffer less tax than salary and which are not themselves subject to National Insurance Contributions. Dividends would, however, be liable to corporation tax within the company. Be aware of the new Dividend rules for 2016/17
It is also worth noting that companies generally have a more benign set of rules around allowable expenses and reliefs. There is a range of allowances and tax-deductible costs that can be offset against a company’s profits. You should always take professional tax or financial advice in the light of your specific circumstances, and this area is no exception. No advice is offered here.
6. Pension possibilities
Rather than an employee director funding pensions out of taxed income, the company can make pension contributions. A company will often be able to make a higher tax relievable pension contribution than an individual and contributions will usually be a tax deductible expense for the company. It should therefore gain Corporation Tax relief against the value of the contribution.
There are no National Insurance Contributions for an employer or employee on pension contributions and contributions are generally not taxable for the employee.
Again, you should consult a professional adviser if you need advice in this area.
7. Options when raising new capital
Whereas sole traders and partnerships generally have to raise new capital from their own resources, companies are able to raise capital at any time by issuing new shares. The new shares can be offered to existing shareholders or new investors, although only public limited companies can offer shares to the public.
Multiple share classes can be used to offer flexibility in rights to vote and therefore control the company, receive dividends and extract capital if the company is wound up. While the company may be established so new shareholders can easily be introduced, it is also possible to include pre-emption rights to protect the interests of existing shareholders.
If the company is going to borrow money from a bank it may be possible to secure the loan without the need for the directors to give a personal guarantee/charge over their house.
8. Dormant companies can be set up
A company does not have to trade to exist. It can be dormant which means it has made no ‘significant accounting transactions’ during its financial year. This can be useful if have an idea and a name for a business but not yet the time or capital to develop it. You’ll need to register the name and maintain the necessary formalities to keep the company on the register, although these requirements for dormant companies are somewhat easier to meet than those for other companies.
9. Exit from the business
Registering a business as a limited company can aid the possibility of selling it in the future, which can be difficult to achieve with other business structures. The original owner may be able to achieve a completely clean break and receive some financial benefit to help fund their future lifestyle – or the start of another business!
Entrepreneurs’ relief against capital gains tax may also be available on the sale of the business.
10. Personal Preference
Lastly, the decision on whether or not to incorporate a company can simply come down to personal preference. If you are familiar and comfortable with running a company then incorporating a new company will seem entirely natural and probably is a preferred course of action.
In many circumstances, running your business as a limited company can offer a strong base on which to expand and develop, although other business structures, like operating as a sole trader, may be most appropriate in other scenarios. Many large and successful businesses have been grown from small limited companies, sometimes bringing great financial rewards – as well a lot of enjoyment – to those who’ve put in so much work to nurture them.
If you decide a limited company is right for your new business, check out how Hetty Verney Accounting can help you start your limited company the easy way.