With the new tax rules on dividend in sight (Apr 2016 – see Budget Review) we take a look at how the landscape has changed in deciding whether to trade through a Ltd Co not.
Until the Chancellor’s announcement in July the decision on whether to incorporate one’s business or not had been simplified by one powerful fact, namely that trading through a Ltd Co attracted less tax if handled correctly.
Given that the other factors in the decision were less tangible and clear cut, this one factor prompted many business owners to go Ltd.
With the Dividend Tax Credit swept aside, we give out take a look at the pros and cons of each option.
The big advantage of unincorporated trading is the simplicity in terms of admin.
Since 2013 some Sole Traders with turnver under the VAT threshold are excused of preparing buisness accounts and simply required to submit their numbers onto the Self Assessment return on the basis of ‘money in’ and ‘money out’.
At the other extreme trading through a Limited Company requires Statutory Accounts, Annual Return, Corporation Tax, P11d reporting on Directors expenses and benefits which entails managing a PAYE scheme, Dividends paperwork, all of which must then feed into a personal Self Assessment.
A good accountant will try to take as much of the hassle out of Ltd Co administration but as Director, the reports submitted are a personal responsibility and paperwork must be reviewed and approved. And of course the added involvement of the accountant costs money. Typically accountants’ fees will be a third to double the amount.
Somewhere in between these extremes of admin sit Partnerships and LLPs. Partnerships will require Annual Accounts and their own Self Assessment Tax Return. Small partnerships may well preserve most of the streamlined administration of Sole Traders but as they grow partnerships tend to get more complex and more similar in burden to the Ltd Company status.
Simplicity and Freedom of Action
Again there is no doubt Sole Trader and Partnership wins in this department.
Often Company Directors struggle with the realisation that the company’s money is legally not their money. The ways that money comes from the Company to the Shareholder are structured and interaction between salary, funds loaned by the Director to the company and dividends can create confusion and stress.
Having said this, the rigour and restriction that Ltd status brings can also be a blessing because it tends to better financial management. In short there is more scope for the Sole Trader to mismanage their finances.
Credibility, Confidence and Risk
Ltd Companies were originally created to encourage investment and this remains their biggest strength. The Limited Liability aspect is a highly significant factor for some businesses where risk of default to lenders or risk of litigation is high.
In addition investors are given confidence from the rigour of reporting and administrative regime. There is an understanding that professional accounting support is probably being provided and it adds up to a package that gives more security.
Of course many Ltd Companies do not have outside investors, but even sole Director Shareholders may consider the extra cost and admin worth it in order to increase the chance of success of the investment they are making in their own business.
In certain industries and for certain lenders, the Ltd Co structure is a precondition for doing business.Tax
The difference in tax between the two options will be marginal for many small business owners.
That said there remains a significant tax advantage of the Ltd status. Companies continue to pay tax at a lower rate than individuals. If money can be retained in a Ltd Company and does not have to be distributed to its shareholders, less tax is paid.
This gives Company Shareholders the ability to stay in control of their tax bill to some extent. Restricting the flow from company to individual in profitable years and augmenting it in leaner years so as to avoid higher rate personal tax rates.
Some other marginal tax benefits continue to apply in the benefits that a Company Director can receive by virtue of their employment.
Here again the Ltd structure wins out in our opinion. Because it is a separate legal entity there is an ease in transferring rights and duties to new investors.
Since the changes were announced it is interesting that few clients already operating as a Ltd Company seem keen to revert to unincorporated status. Perhaps the intangible peace of mind and security that comes with Ltd status outweighs the cost. Perhaps attitudes will change when they see their 2017 Self Assessments tax bills which are likely to be around £2,500 larger than before.
And certainly for any business with ambitions to grow significantly, have outside investors, employees and to establish a business that is more than the efforts of its founder(s) the Ltd status remains attractive. In the end if a business grows big enough, the best fit usually looks like a Ltd Co structure.
The main question for start ups seems to be what their vision of the future looks like and how confident they are of achieving it. The more ambitious the entrepreneur is, the more certain of being around for the long term, the more Ltd Co continues to look like the right choice. The more experimental, the more they about the trading of one person or a few individuals, the more the Sole Trader or Partnership seems the more prudent option.