17 June 09
Are there still savings in incorporation?.......

The decision of whether to run your business as a company or sole trader / partnership is an important one, and one which has been driven predominately in the past by the amount of tax savings that a business would receive by incorporating.  However, with increases to the rates of corporation tax and the decrease to personal tax rates, the question has been raised....is incorporation still a worthwhile option for the small business?

As noted above, historically tax savings have been the driving factor in establishing whether to incorporate your business, however with the current economic environment, the more predominant considerations as to whether to incorporate could rest with non tax issues.

Are the tax savings still there?...

Arguably the savings have decreased over the past years with the reduction in the personal tax basic rate from 22% to 20% and the increase of the company tax rate from 19% to 21%, however from the table below – there are still tax savings there.

Sole Trader

2 Partner Partnership

Based on 2009/2010 rates

Additional tax considerations

Goodwill

For any business that has commenced since 1 April 2002, the benefits of incorporating to realise the business’s goodwill value are very attractive. The owner of an incorporated business should benefit from Entrepreneurs’ Relief on the disposal, and it is likely that the goodwill will achieve a deduction in the company tax computations as an intangible asset. With Entrepreneur’s Relief, a net tax charge of 10% on the individual can be combined with 21% tax relief in the company – which could be viewed as a negative tax burden of 11%.

While one may speculate that this apparent “generous” tax loophole will be closed at some stage, it can be viewed that those in a position to do so should capitalise on the current position.

Unfortunately, if the business has commenced before 1 April 2002, there is no tax relief in the company, but Entrepreneurs’ Relief would still be available giving a very modest tax charge of 10% on the disposal.

Non tax considerations
Some businesses are still focussed on the tax savings of incorporation, but there are also non tax advantages to incorporating your business, which in some cases could have greater financial benefit than the tax savings.

Limited Liability Status

With the UK not just involved in a national economic crisis, but a global one, limited liability status can provide a draw to small businesses and their owners.  In cases where the shares of a company are fully paid, a shareholder (in most cases) can not be requested to invest any further funds in the company.  Although, the directors may have provided personal guarantees to the company’s bank which could be called on.
Because of the economic position, businesses are therefore now at a higher risk of default by their clients and a reduction to their profits due to decreased sales and loss of market interest.  The benefit of limited liability is that an effective barrier is put between the personal assets of the shareholder / directors and the company’s creditors.

Legal Entity

A company is treated as a separate and legal entity in its own right, thereby distancing itself from its shareholders.  The benefit of this is that it can enter contracts and own assets in its own name, along with taking legal action against other parties (and vice versa).

In addition, this enables the sale of the business to be more simplistic in that the shares of the business and can be sold more readily by a simple share transfer, which is contrary to a sale of a sole trader / partnership business.

Corporate Status

By trading through a company, it can sometimes be assumed that the business is somewhat larger than it actually is, thereby adding credibility and commercial respectability to its name.  This can sometimes generate further interest from other businesses in terms of trading with your business as the customer will see you as a dependable business.

Employee Benefits / Succession Planning

With corporate status, a company can establish an approved pension scheme that may provide greater benefits for a company’s employees, when compared to other schemes and those which are available to the self employed.
In addition, employees could be offered an opportunity to acquire an interest in the business progressively, with the potential of a future buyout of the founding shareholders.  It could also be an incentive to employees to reflect their growing status in the business.

If you think that your business could benefit from being in a company or want further confirmation that being in a company is right for your business, please get in touch with one of our advisers.