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July 01 2010

This week, Gerard Gildernew of Cavanagh Kelly considers the advantages of setting up a limited company and the considerations which should be taken before going down this route.

In our report on last week’s budget, we highlighted how in two years’ time, well paid self-employed earners would be paying tax at twice the rate as limited companies – how could that be, you may ask.

Well as the corporation tax rate falls to 24% over time, limited companies will be paying tax on profits at 24%, compared to a 50% personal tax rate for those earning more than £150,000. Take account of the reduced personal allowances for high earners going forward and the lower tax rate for companies of 20% on profits up to £300,000, business taxes could be as much as 150% higher in a sole trade than in a limited company.

So, do we anticipate a flood of new companies to be set up in the coming months?

We may well do – however, as with any proposed change in your business structure, there are pros and cons to be considered. It’s not always as easy as it may first appear.

So what are the advantages?

Tax – Yes, the differential in personal and corporate tax rates will be a driver for change. That said, you need to consider the expected level of profits in the future and assess the real advantages of changing to a limited company.

Limited liability – it does what it says on the tin. In a limited company, liability is largely limited to the extent of the investment by the shareholders and the directors. In a sole trade and a partnership business, all your assets (including the family home) are available to creditors in the event of a claim.

Tax-free drawings – the notional value of your business (goodwill) will be transferred to a new company. You pay tax on the deemed profit on the sale of the business to the company but at the low rate of 10% capital gains tax, and thereafter you can withdraw these funds tax free, cash permitting.

And the disadvantages.

Getting your money out – in a sole trade or partnership, you pay income tax on profits earned. In a limited company, the company pays corporation tax on its profits and you will then also be taxed on any income taken personally. Take care to consider the funds you need personally and the overall tax bill rather than looking at the business in isolation.

Limited or part limited? – more and more banks and suppliers are requesting personal guarantees from directors and shareholders. When a company becomes insolvent, the veil of incorporation can also be lifted. Whilst operating in a limited company, the directors and shareholders may still find themselves liable.

Compliance – limited companies must file annual returns and annual accounts to the Companies Registry. Summary information is available in the public domain. The cost of filing returns and preparing accounts for a limited company can be higher.

The key point to note is that it is not as quite simple as buying a shelf company and transferring the trade. A full review of your personal financial affairs should be conducted to ensure that any decision taken in respect of your business fits well with the management of any other income sources or financial dealings you may have.

Gerard Gildernew is Partner in CavanaghKelly and can be contacted at Gerard.Gildernew@cavanaghkelly.com

Have you a question you would like answered? If so, please email us to businessreport@cavanaghkelly.com