Incorporation – the pros and cons

Many businesses became limited companies because of the tax savings available - but the new dividend tax has reduced these benefits considerably.  You can read more about the tax savings from trading as a limited company here.

However from a tax perspective, trading as a limited company does provide you with the ability to manage your tax liabilities more effectively.  This can be quite a big advantage if you want to manage how much you pay the taxman.

But putting the tax situation aside, we've listed below some of the benefits and disadvantages of trading as a limited company.

Benefits of trading as a limited company:​

  • Separate legal entity

    Because the company is a separate legal entity it can sue and be sued in its own right.

    Therefore, if you believe there is a reasonable chance of being sued then it may make sense to trade as a limited company.

    For example, many magazines will trade as a limited company because they may be at risk of being sued over inflammatory or derogatory remarks – this is why ‘Private Eye’ magazine is published by a limited company!!
  • Limited liability

    The shareholders’ liability is limited to the amount of issued share capital they hold.

    If the company was to become insolvent whilst owing significant amounts of money, the creditors could not require the shareholders to provide any further funds towards paying off those debts.

    However, a word of caution. As noted below, a lot of lenders (banks for example) will require the directors or shareholders to give a personal guarantee when obtaining finance. This means that the lender can still go after the directors and shareholders personally should the company go bankrupt.
  • Bank loans and overdrafts

    In some instances, it can be easier to obtain finance as a limited company because the bank can obtain what is known as a “floating charge” over the assets owned by the company.

    This gives the bank extra security and gives the company greater borrowing power.
  • Transfer of ownership

    Effective ownership of a company can be readily transferred (subject to the articles of association) by selling the shares in the company. However do give due consideration to the capital gains tax and inheritance tax implications before undertaking such a transaction.
  • Planning for retirement

    Trading through a limited company offers a greater degree of flexibility when it comes to your pension provision.
  • Perception

    Rightly or wrongly, a limited company can often be perceived as a more ‘established’ or ‘bona fide’ business.

Disadvantages of trading as a limited company:​

  • Losses

    Because the company is considered to be a separate legal entity, any losses made by the company can only be set off against any profits made by the company in prior years or any profits which the company may make in future years.

    This may be a great disadvantage - especially in the early years of the business when the likelihood of losses is high.

    In direct contrast the losses made by a partnership or sole trader in opening years may be offset against other income in current and prior years (subject to certain rules).
  • Personal guarantees

    Whilst finance may be easier to obtain as a limited company, banks may (and quite frequently do) require directors to give personal guarantees that they will repay any borrowings should the company become insolvent.

    Some suppliers may also require personal guarantees and so this may reduce directors’ limited liability significantly.
  • Visibility of results

    Because a company’s Statutory Accounts are filed required by law to be filed at Companies House, then the company’s results are freely available to the public (and your competitors).

    Companies who are defined as small (broadly those with a turnover less than £6.5m as at 2014) can file abbreviated annual accounts. These accounts do not include any profit and loss information but will still have the balance sheet included.
  • Withdrawing funds

    It’s important to remember that the company’s money and your money are completely separate – something which a lot of limited company owners forget!

    And there’s a nasty tax charge lurking if you don’t make sure that you do things correctly.

    However if you’re a sole trader or partnership, you can generally introduce or withdraw cash from the business without any tax implications.
  • Expenses

    When you are director of a company you can only claim tax relief on expenses which are incurred wholly, exclusively and necessarily in the performance of your duties as a director.
  • Administration

    Running a company involves a lot more administration then being a sole trader or running a partnership.

    For example, a limited company is required to file annual returns with Companies House and must produce dividend tax vouchers and minutes for any dividends paid.

    A company’s accounts must also be in a format which is prescribed by the Companies Act 2006 (unlike sole trader accounts which can be set out in any format). These accounts are then known as ‘Statutory Accounts’.

    Many of these requirements will incur penalties if they are not dealt with on time - and the directors are at risk of prosecution if they don’t fulfil their statutory obligations correctly.

    However we can help you with all of your statutory obligations making sure you don’t incur any penalties.

    And whilst the additional administration required means additional costs, these can often be more than offset by the tax savings gained by trading as a limited company – but make sure you get advice as to what these might be!

If you'd like any further information as to whether trading through a limited company is right for you, feel free to get in touch.

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Why Friendly

The Friendly Accountants are Alternative Accountants. Unlike traditional accountants, we look forward - not back.

We work with small businesses and contractors/freelancers who want to embrace the world of online software and the benefits this brings.

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