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Business
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6/3/2011
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To be or not to be a limited company?
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An inevitable question you will come across during the life of your business will be whether or not to operate as a limited company. Umesh Modi explains the facts...
The decision to go it alone can be daunting enough, therefore the simplest way of getting started is usually to operate as a Sole Trader. At the initial stages this can have its own advantages especially where losses or relatively low profits are anticipated in the opening years. However, as your business matures it is likely that your business may be better off as a Limited Company. It is at this point many people are apprehensive as the red tape involved in running a company is often perceived by many as being over complicated and time consuming. Though this can be true to some extent, with the aid of a good accountant the process today with the aid of online filing, this can be a seamless and pain free experience than originally anticipated.
The Advantages of a Limited Company
One of the main advantages to incorporating is the ‘limited liability’ of having your business as a separate entity. This offers the ability of keeping your business affairs separate to that of your personal affairs, and to anyone who works for themselves will know this can be a very thin line indeed! However more importantly unlike a sole trader, where ones personal assets such as a house or car can be at risk of being seized to pay the debts of your business in times of crisis; a limited company will shelter such burden and responsibility. The shareholder liability is essentially only limited to the amount he or she has invested in the company. It is important to note that a company has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued. You as the shareholder of the company cannot be held responsible for the debts of the corporation unless you've given your personal guarantee. Other advantages of operating via a limited company are;
- Corporations Carry On – A company has an unlimited life span unless it is wound up. The corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes hands.
- Raising Money Is Easier: Corporations also have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital. This is a big advantage because equity capital generally does not have to be repaid and incurs no interest. (Of course, by issuing shares, you are reducing your percentage of ownership in the company).
- Income Splitting: Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company's earnings. A shareholder does not have to be actively involved in the corporation's business activities either to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate.
- Increased Business? - Having ‘Ltd’ as part of your company's name may increase your business, as people perceive corporations as being more stable than unincorporated businesses. If you're a contractor, you may also find that some companies will only do business with incorporated companies, because of liability issues.
- Potential Tax Deferral & Income Control. Saving the best to last is the potential tax saving a limited company can offer. As a sole trader you will be taxed on the net profit with little or no potential of tax saving. However, with a limited company your income and indeed your tax liability have greater flexibility. By having a company you can decide the best way of extracting your money, this alone can offer you a tax saving as deferring paying some tax (by taking out less) will enable you to realise tax savings if you are then in a lower tax bracket, or if the tax rates have, as in recent times change.
Disadvantages of a limited company
So far incorporating your business sounds like a great idea but there are also potential disadvantages to incorporating that need to be considered as follows.
1. Another Tax Return - When you incorporate your small business, you'll have to file two tax returns each year, one for your personal income, and one for the company. This, of course, will mean increased accounting fees; however the overall affect is generally outweighed by the tax savings.
2. Increased Paperwork – As mentioned there is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. This includes minutes from meetings, corporate documents etc.
3. Some Tax inflexibility’s - Unlike a sole proprietorship or partnership, corporate losses can't be deducted from the personal income of the owner. A corporation doesn't have the same flexibility in handling business losses as a sole proprietorship or a partnership. In a corporation, however, these losses can only be carried forward or back to reduce the corporation's income from other years.
4. Liability May Not Be As Limited As You Think - The prime advantage of incorporating is the gaining of ‘limited liability’, however in some cases this may be undercut by personal guarantees and/or credit agreements required by many lending institutions. If a company has insufficient assets to secure a loan, creditors often insist on personal guarantees from the business owner(s), so although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can't meet its repayment obligations.
Abbreviated disadvantages
1. Another Tax Return – An Additional Corporation tax Return will be required as well as your personal Tax return
2. Increased Paperwork – A company is required to keep a record of more information with regard the conduct and decisions made within the company. i.e. minutes
3. Losses - corporate losses can't be deducted from the personal income of the owner
4. Personal Guarantees- . If a company has insufficient assets to secure a loan, creditors often insist on personal guarantees from the business owner(s)
Mr Nurul Ali of Silver Levene provided research for this article.
Disclaimer
Umesh Modi BA ACA, is a Chartered Accountant and Tax Advisor, and a partner at Silver Levene (Incorporating Modiplus+). He can be contacted on 020 7383 3200 or umesh.modi@silverlevene.co.uk
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