INCORPORATION OR SELF-EMPLOYMENT ?
Overview – The Budget of 2002 pushed the tax savings balance in favour of the legal shelter of incorporation over other the other forms of businesses such as sole trader, partnership, or self employed individuals in self employment. However, The Chancellor of The Exchequer, attempted to equalise the situation in the 2004 Budget. By 2006 the taxation advantages had all but gone.
Other matters to consider are the compliance costs of operating a limited company. However this is not putting people off incorporation. According to Inland Revenue’s Working Together publication 35,000 new limited companies per month were being formed by the start of 2004. Why?
Well here are a few reasons:
The business is legally sheltered in many ways, as a limited company, especially if it fails, your exposure is not one of personal liability, subject to guarantees given and other undertakings in law assumed to be observed by companies directors like; preparing financial accounts; employment rights; and statutory filing duties ; The relative ease of selling it on as a going concern or retaining some sort of involvement in it; The introduction of audit exemption; Converting one’s un-incorporated business into a limited can create profit from the disposal. Subject to the Capital Gains Tax rules of course and agreement on the valuation used for a disposal; And finally; A family company must assist families with pension planning and succession issues. Inheritance Tax Planning with reference to the issued share capital is also simplified.
The Pros & Cons of Incorporation:
Possible advantages of incorporation
* Incorporation normally provides limited liability. If a shareholder has paid fully for his or her shares, he or she cannot normally be required to invest any more in the company. Although companies with bank borrowings often have to provide directors’ personal guarantees, the protection of limited liability will generally apply in respect of liabilities to other creditors.
* A company enjoys legal continuity – it can own property, sue and be sued.
* Effective ownership or part ownership of the business may be readily transferred, subject to the provisions of the Articles of Association. Whilst such transfers may well be covered by inheritance tax business property relief, the capital gains tax position needs careful review.
* Normally a bank can take extra security by means of a ‘floating charge’ over the assets of the company, and this will increase the amount that can be borrowed compared with a sole trader or partnership.
* Shareholders can be paid in dividends (currently free of NICs) but strict company law formalities must be observed.
*The National Minimum Wage does not apply to directors (as they are office holders) unless they have a Contract of Employment.
* Growing businesses can re-invest profits after an corporation tax charge of 20% (if profits are below £300,000), compared with 40% income tax for higher-rate tax paying sole traders and partners together with a 1% class 4 National Insurance charge on profits over £34,840.
* Accumulated funds could be withdrawn on a sale of shares with the benefit of capital gains tax (CGT) business taper relief which reduces the effective CGT rate to 10% once shares have been held for two years.
* Corporate status is sometimes thought to add to the credibility or commercial respectability of the business.
* A company can establish a registered pension scheme, which may provide greater benefits than self-employed schemes.
* Employees may, with adequate safeguards, be offered an opportunity to buy their own stake in the business, reflecting their commitment and importance to the company.
* The liability of executors acting for deceased shareholders, or of trustees, is clearly defined.
Potential disadvantages of incorporation
* Formation of a company incurs legal and administrative costs, which may include new accounting records and possibly systems, new PAYE system, new business tax reference, new VAT registration, new stationery etc.
* Customers, suppliers and service providers must be informed of a change to limited company status.
* The tax position arising on the incorporation of an existing business needs careful analysis. It may be possible to defer capitals gains tax on the transfer of goodwill etc, but the timing and effect of cessation on income tax must be closely planned.
* Annual Accounts must comply with the requirements of the 1985 Companies Act. In most cases, a statutory audit is not required for companies with an annual turnover of £5.6 million or less. The statutory audit involves work over and above that which is normally carried out for a sole trader or partnership.
* A company’s accounts must be filed on public view with the Registrar of Companies. An Annual Return must also be submitted to the Registrar of Companies together with a filing fee of £30 (£15 if filed online).
* The company will be taxed on its profits of each accounting period, as opposed to the income tax ‘current year’ basis for sole traders and partnerships. A company must file a corporation tax return.
* Funds withdrawn from a company normally give rise to tax liabilities, whereas owners of unincorporated businesses can generally introduce and withdraw cash without tax implications.
* Remuneration for directors is subject to both employee’s and employer’s National Insurance liabilities – currently up to 23.8%. For example on a remuneration of £12,000 there is a NI liability of £1,658. Both the company and its directors are liable to NIC on many benefits in kind, and a form P11D must be prepared for each director, whatever the level of earnings. This can lead to extra work in filing a tax claim for reimbursed expenses etc for which individual tax relief is available.
* Tax on directors’ remuneration paid monthly is payable on the 19th of the following month (22nd for electronic payment) through the PAYE system, and corporation tax is payable nine months after the end of a company’s accounting period. For a sole trader or partnership, tax is generally paid by instalments on 31 January and 31 July on the current year basis. The ‘credit period’ depends upon the choice of accounting date, and you should contact us for further advice on this.
* The ‘IR35’ legislation relating to personal service companies could be relevant, especially for IT contractors and other service providers who work for only one customer.
* Companies pay tax on capital gains at their corporation tax rate (19% for profits up to £300,000). In a company, a capital gain is reflected in the value of its shares and if these are sold a “double charge” to capital gains tax can arise. This may be avoided if assets that are likely to increase in value are owned either outside the company or within a self-administered pension scheme, or if a company is sold complete with its assets
* An individual has greater flexibility in dealing with trading losses.
* A company director is more at risk of criminal or civil penalty proceedings, eg for late filing of accounts or for breaching the insolvency rules.
WORKING FROM HOME
The Self Employed Home worker – These claims amount to both;
a) The space set aside to operate a business from home.
b) The ‘time basis’ here. This time given over to running the business from home is a consideration.
It is particularly important to highlight the basis of the claim to the Inspector in the first year of the claim. The allowance represents something of an unwritten concession by Inland Revenue and as such should not be excessive. Anything over £104 p.a. is open to being interpreted as excessive!
Contact us for further advice.
Employee Home workers – This area of economic activity continues to evolve due to computers, fax machines, and answering machines etc being common place in the home nowadays.