Why company incorporation can be good for the sole
ONE of the first questions an entrepreneur should ask is whether to set up a company to run the business or to operate it in one's own name as a sole trader.
Whether to incorporate depends on owners' expectations and future levels of profitability.
The basic rule is to incorporate only when it generates more taxable profits than the owner needs for their income. There are extra costs in setting up a company so there's no point if there's no surplus taxable profits. The big advantage of limited liability is that one has some protection from creditors but there are other advantages.
A company pays corporation tax on profits at 12.5pc. At this low rate, the benefits of retaining profits in the business are significant. This way tax can be paid at any time and not necessarily in the year the profit is earned. Company directors only pay income tax on income paid to them by way of salary.
But if an individual operates as a sole trader, they pay income tax on profits in the year, irrespective of whether they are drawn or not.
Another advantage of limited liability is that as a sole trader, the maximum pension contribution allowed for tax purposes is 15-40pc of annual earnings, (varies on the individual's age).
A company, however, can introduce a pension fund for directors and the levels of contribution are far more generous. Also directors can make extra contributions to the pension fund. Generally, payments made by the firm to the pension fund are fully deductible for corporation tax purposes and there is no benefit-in-kind implication for directors for payments made on their behalf .
It is also possible to create stock options or share schemes to retain and motivate key staff.
There are, however, far more costs associated with running a company as opposed to a sole trader. Company returns, and corporate tax returns have to be filed annually along with monthly payroll returns. Also accounts may need to be prepared and audited.
Directors will still need to be making their personal tax returns too.
And if an individual has already been operating as a sole trader, and wishes to incorporate, then capital gains (asset transfer tax) must be considered.
Simon Ball is a tax adviser at SB Tax Consultants. firstname.lastname@example.org