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To Incorporate or Not to Incorporate? Here’s What to Consider
05 Sep 2024
Changes in the tax landscape over recent years have made operating as an incorporated business less appealing from a tax perspective, for both new and existing businesses. Factors like reduced national insurance contributions for the self-employed, increased corporation tax rates, and higher tax rates on dividends have undoubtedly played a part. A question we are often asked is “is incorporating still worth it?” The answer, unfortunately, is “it depends.”
Tax considerations are, of course, not the only factors you need to deliberate on when considering incorporation. It is important not to put the “tax cart” in front of the horse, so to speak.
What are the benefits of incorporating?
Beyond the tax landscape, incorporation still offers several benefits such as:
- Limited liability – safeguarding your personal assets from potential business liabilities and debts.
- Facilitating succession by ensuring the business remains operational independent of its original owners.
- Simplifying the investment process, and indeed, potentially, making a business more attractive to investors.
- Facilitating the ability to offer employees a stake in the business through share issuance.
- The availability of different share classes to vary the rights of different shareholders, increasing flexibility in your business planning.
Does Incorporating have drawbacks?
On the other hand, there are of course still non-tax drawbacks like:
- The initial set up costs of incorporating, particularly for established businesses wishing to transfer into a company.
- Ongoing, and sometimes onerous, compliance requirements such as filing annual accounts and returns, adding to your workload (or another overhead).
- Reduced privacy due to it being a requirement that more information about you and your business is publicly available.
However, despite these considerations, we appreciate that tax does play a significant role in business decision-making (otherwise, we might be out of a job!). So, below we explore some of the tax implications of incorporating. First of all, let’s consider how one might decide if it’s beneficial to incorporate from a tax perspective.
Illustration – Trader drawing down all profits versus retaining profits
Joe B owns a small sole trading business providing web development services with moderate profits year on year of around £40,000. Joe doesn’t currently take a salary and instead uses his profits to fund his lifestyle, particularly as his business requires little recurring capital investment. He is considering whether incorporation might be beneficial.
As a sole trader, Joe’s usual income and tax liability looks as follows:
| Profits received | £40,000 |
| Taxable income | £27,430 |
| Income tax liability | £5,486 |
| National Insurance (NICs) due | £2,648 |
| Net income | £31,866 |
If Joe were to set up a company and draw income in the most tax efficient manner, assuming all other factors remain the same, it would look something like this:
The company – Incurs corporation tax on taxable profits
| Company’s taxable profit | £40,000 |
| Profit less director’s salary and employer NICs | £26,951 |
| Corporation tax at small profits rate | £5,121 |
| Profit after tax | £21,830 |
Joe – Incurs income tax at non-saving income rates on salary, and dividend rates on dividends
| Salary | £12,570 |
| Employee NICs | £0 |
| Dividend | £21,830 |
| Income tax liability | £1,910 |
| Net income | £32,490 |
Although Joe’s income tax liability has reduced, his net income has increased by less than £1,000 after incorporation. This calculation doesn’t take into account the additional costs (in terms of both time and money) incurred in running a limited company, such as additional compliance requirements, which would likely skew the result in favour of operating a sole trader.
However, if Joe didn’t use all his profits, and instead wanted to retain profits for future investment, incorporation would become more attractive. This is because, as a sole trader, Joe is taxed on all profits, whether he uses them or not. In a company, although the profits will be subject to corporation tax, he only incurs personal tax on salary and dividends received.
This is of course a very basic illustration, but it goes to show how important the context in which you and your business are operating is in making the decision to incorporate.
It is also important to note that the ongoing tax implications of operating a business through a company are not the only tax implications to consider. If you are thinking about incorporating an existing business, the transfer itself has various tax implications depending on the manner in which the transfer takes place. One again, the best option for your business depends on myriad factors including: the assets used in the business; the availability of cash; commercial factors; and tax cost.
How we can help
As can be seen, choosing the right business structure depends on various tax and non-tax considerations. WR Partners’ tax consultancy team are experienced in assisting clients to navigate these complexities and find the best solution for their business.
Should incorporation be right for your business, we offer various services to provide ongoing support throughout your journey from accounts and tax compliance, company secretarial services, tax consultancy, and corporate finance services.
We love meeting new businesses. Contact our team to see how we can enhance and protect your financial position. Or if you’d prefer to speak to someone directly just give us a call on: 08000 664 664 or email: hello@wrpartners.co.uk.
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Get in Touch
We love meeting new, exciting businesses. Get in touch with our team to see how we could enhance and protect your financial position.
Or if you’d prefer to speak to someone directly just give us a call on: 08000 664 664 or email: hello@wrpartners.co.uk.
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