There have been numerous attempts over the recent years to improve the lot of small businesses by introducing measures to try and reduce the administrative burden and encourage enterprise. Sadly, the financial aspects have changed so much that it is hard to be definitive as to the benefits of incorporation for a small business over staying as a sole trader. Many of the non-financial benefits, however, still remain and it will be for each individual to assess their personal circumstances to decide what works best for them.

Key benefits of incorporation
One of the major benefits of becoming an incorporated business is that your financial liabilities are capped at the amount of share capital invested in the business. As a sole trader or partnership, you are fully liable for the debts of the business or any judgements for fines, penalties or claims against the business. This may be acceptable if you are engaged in work when the risks can be easily identified, but can be substantial in areas such as construction or financial services. Insurance can be obtained (at considerable cost) to mitigate some of this financial exposure, but at the end of the day, trading as an individual means that your personal assets are at risk. Of course, even as an incorporated business you may have to pledge assets or security to the bank or other financial institution to gain lines of credit, but at least these will be capped and at your discretion.

One of the major drivers for small businesses to incorporate has been the potential tax savings to be had. Incorporated businesses pay tax at 22% (up to £300,000 profit) which leaves more money available for distribution as dividends to the shareholders. This means that a husband and wife trading as equal partners in a business making £30,000 profit could save nearly £1,600 in tax and National Insurance if trading as a business rather than as a partnership. This rises to over £7,000 per annum where the business makes £100,000 of profit. This assumes that both partners take a salary up to their tax free allowance and the remainder in after tax dividend income from the business.

Other considerations
So the financial motive for incorporation can be great. But there are other issues to consider since, as always, incorporation comes with some additional costs and burdens.

If you currently trade as a partnership then there may be issues arising on transferring assets into the new business. This may involve capital gains issues (if property or other tangible assets are involved) or valuation challenges for items such as intellectual property. There may be options for deferring capital gains tax payable until the asset is sold within the business, but this is a specialist area and professional advice should be sought before choosing the appropriate course of action.

A limited company is treated, in law, as a separate entity and, therefore, is capable of continuing in existence after the initial shareholders move on. As such, it becomes easier to value the business and for existing owners to sell and move on at the appropriate time. Similarly, the mere fact that it is a standalone business can add credibility to the operation.

The downsides
A limited company has to have financial records prepared and audited each year to a higher standard than those needed for a sole trader. This additional compliance cost can be considerable especially if the business accounts need to be audited by a registered auditor. Shareholders and directors details have to be filed on public record at Companies House. This can lead to a loss of privacy and additional intrusion from unwelcome callers. Likewise, reports and accounts have to be published – although the rules have changed in recent years such that abbreviated financials can minimise what is released into the public domain.

The responsibility for running a business is also defined and clearly sets out the responsibilities of directors for managing a business so as to meet deadlines for filing accounts, avoiding trading whilst insolvent and fraudulent trading.

Forms of incorporation
There are many forms of incorporation available these days so choosing the right form could be important for your type of business. Incorporating your business in another jurisdiction could also bring benefits for certain types of trades. So whilst it may be financially advantageous to consider incorporating, there are many other nuances to consider that may have a bearing on your decision. The best plan is to consider carefully your options with a qualified and experienced professional advisor since once you have made the move to being a limited company or perhaps a limited liability partnership (LLP); it can be costly and time consuming to step back. The benefits of protection from financial liability can be a considerable peace of mind although the moral consequences of your actions remain!

If you enjoyed this post, make sure you subscribe to my RSS feed!

You might also like to read...