TT67: Business Incorporation

Many businesses start as sole traders or partnerships, but after a short period of time often expand into serious concerns. It is then that the proprietors usually begin wondering whether they ought to be trading via a limited liability company (‘company’) or a limited liability partnership (‘LLP’). There are four important aspects to be considered:

  1. Limitation of liabilityA sole trader is personally liable for all the debts and liabilities of their business.Trading via a limited liability vehicle allows the owner of the business to distance themself from personal liability for the trading debts of the business. (However, owners could remain liable for certain debts, for example the bank might insist on personal guarantees.)
  2. Commercial presentationA company or LLP may create a better image to customers and suppliers. However, the benefit of limited liability comes with the downside of more publicity. Companies and LLPs are required to file annual accounts at Companies House along with details of directors and shareholders (or members, in the case of a LLP).At present most companies under £5.6M turnover can take advantage of filing abbreviated accounts consisting of only a balance sheet and certain disclosure notes that hide key facts such as director’s earnings or shareholder’s dividends. The pending Company Law rewrite is expected to end this and force all companies to file simplified, full accounts showing more financial information.LLPs have broadly similar rules for abbreviated accounts, but depending on profitability their full accounts may disclose the income of the higher earning member and an analysis of members’ earnings in bands.
  3. Tax consequencesA company has its own tax return and will pay tax on its profits at a rate usually lower than the sole trader. This allows businesses that make more profits that the owners take for their living expenses to accumulate profits at a lower rate of tax. Remember though, such decisions as company cars and salary versus dividend become quite complex to avoid paying too much tax. However, giving employees shares and retrieving them later can be fraught with tax consequences.For LLPs the situation is very different. A LLP, will split all profits between the members and those members will pay tax on the profits as individuals at their full rate of tax. If much of the profit is tied up in long-term items such as fixed asset acquisitions or working capital the members might be paying tax on profits they can not yet draw. However, the tax rules allow members to join and leave trading LLPs with little or no tax consequences or downsides.
  4. CostsA company has its own legal identity and it requires accounts in a format prescribed by the Companies Act 1985 and a host of accounting standards. Also it requires a Corporation Tax Return for each year of trading. The cost implications of this must be set against remaining unincorporated.Similarly a LLP must prepare accounts in a prescribed format, but as it is taxed just like a partnership then the tax return should not place a greater cost on the business compared to an unincorporated entity.

Barnes Roffe Topical Tips

  • The decision to incorporate a business is central to the strategy of the business owner and must not be taken lightly.
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