If you are self employed and trade as a sole trader (or a partnership), you may wonder why you should incorporate your business – i.e. transfer your business to a limited company. There obviously has to be some benefit.
Well, there is. In broad terms, there are 3 main reasons why businesses choose to trade through a limited company:
- Limited liability.
- Enhanced reputation (larger organisations prefer to deal with limited companies).
- Lower tax rates.
Without doubt, one of the biggest attractions is the lower tax rate, which effectively saves on National Insurance. For instance, if you make a taxable profit of £30k as a sole trader, your tax charge is likely to be in the region of £6.5k. If you operate the same business through a limited company, the tax liability can drop to £4.5k, saving £2k in tax each year.
However, there are many other factors to consider. For instance:
- A limited company is a separate legal entity, so the money that sits in the company bank account belongs to the company, not the shareholders or directors.
- If you take money out of the company without ‘legitimising’ it (using such things as dividends) and the money is outstanding at the year end, there are corporation tax and benefit in kind implications.
- You need to ensure that you act responsibly, which includes making sure that the company doesn’t trade whilst insolvent (which can seriously affect your chances of getting credit from suppliers).
- You may need to change the way you claim tax relief on motor expenses, particularly if you use a car.
- If you are a subcontractor operating under ‘gross’ status, transferring your business to a limited company will mean reverting to 20% and reapplying for gross status when you have met the criteria.
The aim of this article was simply to highlight that incorporation is a straight forward process, but there are many things that should be considered before a decision is made, and traps to avoid once the decision has been made. If you want to read about how things can go wrong, see this recent case study.
We can help in the process, including setting a limited company up. Please contact us if you wish to discuss this further.