At the date of this article corporation tax for SME’s is 20% but the chancellor has recently indicated that this could go lower ...to 15%. However the down side is that the rules on taxation on dividends has changed from this April and this has altered the point at which trading through a Ltd company merely to save tax occurs. However Ltd companies are more than just a tax saving vehicle are there any other reasons why trading through a Ltd company might be appropriate ? Lets examine the key factors to consider.
The company as a person. A ltd company is in effect an artificial legal person so it is able to enter into contracts in its own right. This means that the affairs of the shareholders and directors [ often one and the same in a small business ] are quite separate from the affairs of the company. There are however some exceptions to this. There are situations where directors but not shareholders can be held responsible for their actions with respect to the activities of the company. This is known in legal parlance as ‘lifting the veil ‘ in other words looking behind the veil of incorporation to those directors who are the real thoughts and minds behind the actions of the company. There are two common instances where this ‘lifting the veil’ could be relevant for directors of SME’s. Firstly wrongful trading, this is where the directors continue to allow the company to trade when they knew or ought to have concluded that the company could not avoid insolvent liquidation. In simple terms the company can't pay its debts. The second is where there is for example a serious breach of health and safety legislation by the company and this can be shown to be a result of neglect or negligence on the part of the directors. Penalties in these cases can be severe resulting in imprisonment and fines. It is possible for directors to have personal liability insurance, sometimes know as D&O insurance to protect them against any damages claims from regulators or shareholders and creditors.
Raising finance. Many people are unaware that private limited companies can raise finance either through issuing debt or by issuing shares. What they cannot do is offer shares to the general public though. However for example a customer of a business could buy shares to help fund expansion for a key supplier. The original shareholders [ known as the subscribers ] can buy more shares and hence put money in to the business for expansion, This is often a cheaper and more cost effective method of raising finance than a bank loan especially considering banks often ask for personal cross guarantees from the directors meaning the directors are personally liable if the company can’t pay its debts. There is also a potential exit route for investors without affecting the continued operation of the business.
Limited liability. Subject to some of the circumstances I’ve spoken about in the previous paragraphs with regard to directors, the liabilities of the company are separate from those of the owners [ shareholders ] and directors. A sole trader or partner ship has full liability for any of the business debts over and above the money that they have put into the business. Its not uncommon for established businesses to have liabilities that far exceed the personal assets of the owner, if there is a problem..say a large customer can’t pay and the business fails then the owner can end up personally liable for any debts..on top of losing his/her job. With a company this can’t happen so if the company is forced to cease trading the shareholders are potentially free to start a new business or go back into employment whilst their personal assets are unaffected.
Succession Its perfectly true that a sole trader or partnership can employee people in just the same way as a company can but there is one crucial difference. If a sole trader becomes incapcitated then the business has to cease because he/she has the sole legal right to enter into contracts and deal with the assets of the business. Similarly with a partnership at the very least if there are only 2 partners the partnership agreement would need to be dissolved or revised if there were more partners. A limited company structure prevents these problems. If a shareholder dies say, then the shares simply pass to his/her heir as part of the estate. If there is a sole director situation then obviously this is more problematic but the business can still continue to trade. These point are worth serious consideration because we shouldn’t forget that businesses are not just about owners, directors and shareholders, there are often employess and families who rely on the business continuing so as to provide them with an income.
How others see your business. It’s a paradox that Limited companies are often seen as more stable and professional than sole traders and partnerships. This could have an impact on the reputation and ‘brand image’ of your business and this could be a positive in the minds of both customers and suppliers which could be beneficial in terms of building the business up.
Tax efficiency. This is changing and will change even more over the coming years. The effects of globalisation have made it more difficult for governments to raise taxes directly from business ie through corporation tax. Witness the recent spats between HMRC and the likes of Starbucks and Amazon. One solution to this problem is to minimise direct taxation on businesses and increase indirect taxes ie consumption taxes and personal taxation on dividends and there is evidence to support this given the current plans by the government. The recent changes to tax on dividends and simplification of benefit in kind rules means that the earnings point at which a tax saving is realised by running a profitable business as a company versus a sole trader or partnership has moved up. This is an area that needs careful consideration
Directors responsibilities It's important to understand that there are some additional responsibilites for directors of a limited company. There is an obligation to file annual accounts with Companies House and to complete and file a corporation tax return with HMRC there are deadlines for submission and penalties for being late. The directors also need to file something called a 'confirmation statement' [ this used to be called an annual return ] and maintain a register of PSC's or people with significant control. For small owner managed companies these matters are relatively straightforward but it's important to keep up with changes in legislation and for this reason most people engage an accountant to deal with filings, accounts and tax return. However it's important to emphasise that the responsibility for accurate, timely submissions always sits with the directors.
So deciding whether or not to trade through a limited company for your business should never be a decision just based on potential tax savings. There are lots of advantages as I've pointed out above but some extra costs and responsibilities too.