Incorporation is the process by which any business can register itself as a limited company. To operate as a limited company in the UK, a company needs to be incorporated at Companies House under the Companies Act 2006.
While the paperwork can become quite a burden in the long run, there are some benefits that come with forming your own limited company. Here's a quick look at them:
The benefits of incorporation
Choosing to incorporate your business can be one of the most effective ways to protect your personal assets. A corporation is a separate legal entity responsible for its own debts. This means that, generally, creditors can seek payments only from the assets of the corporation itself, and not from the shareholders.
For a corporation, raising capital can be easier. A corporation can issue shares of stock and this can facilitate the development and growth of a small business greatly. Also, in most cases, lenders are more inclined to approve applications from corporations rather than unincorporated ventures.
2. Selling it on
Moreover, there is no legal business structure as enduring as a corporation. A corporation has an unlimited lifespan and selling it can be easier than selling an unincorporated business.
Another generally overlooked benefit of incorporating is the legitimacy and authority a small business can gain. Clients or partners prefer to do business with an incorporated company because of liability issues or even the simple desire to keep the collaboration as professional as possible.
Running your small business as a limited company means that you are likely to pay much less in personal taxes than a sole trader.
In the UK, a sole trader pays income tax on the business’ profits calculated each year by filing a self-assessment tax return. This details your business sales and outgoings after your allowances are considered. Limited companies are instead subject to the UK Corporation Tax which is currently set at 19%.
By choosing to take a small salary as a director and shareholder of a company, you can draw most of your take-home pay in the form of dividends. You can also alleviate the financial burden that comes from National Insurance Contributions, as limited companies dividends are taxed separately and are not subjected to the same contributions on income as sole traders are.
One of the main issues that make small business owners quiver when considering forming a business corporation is that they will have to pay some form of “double taxation”, which means that income is taxed twice, once on the corporation and a second time when the money is paid out to the shareholders.
In reality, double taxation only occurs when a corporation pays money to people who do not actively work for the business. This is mainly because any money paid to people working for the corporation can be deducted from the corporate tax as reasonable and necessary business expenses, or salaries and bonuses, so the company doesn’t need to pay taxes on it. If, instead, money is being paid to people who do not work for the business, then that is subject to double taxation.
Different types of companies
Most companies in the UK are limited liability companies. This means that the liability of the members of the company is limited by shares. There are four main types of company:
- Private Unlimited Company: a company without a share capital but no limit to members’ liability.
- Private Company Limited by Guarantee: this type of company does not have a share capital and its board members are guarantors. Their liability is equal to the amount they originally decided to contribute to the company.
- Private Company Limited by Shares: a company with a share capital and each member’s liability is limited to the number of their unpaid shares. It is important to notice how a private company cannot offer sales of its shares to the general public.
- Public Limited Company: a public company has a share capital and each member’s liability is equal to the unpaid amount on their shares. It may be quoted on the stock exchange.
LLP or Ltd?
An LLP is a midway solution between the more traditional partnership and a private limited company. It has all the benefits of a partnership and limits your exposure.
Usually, an LLP is a partnership between two individuals, such as two solicitors wanting to become business partners. This will likely mean that they won’t recruit a large number of employees and keep things running on a small scale.
However, an LLP can be less tax efficient if it employs lots of people. This is because any income is still personal income and will be taxed as such. Because of this, the tax burden can be higher than what you’d pay as a limited company and its profit cannot be retained the same way.
The UK is known worldwide for its productive investment environment, which is generally pro-enterprise. Widely speaking, the process of incorporating an existing business or a start-up is advantageous, but there are many legal, taxation, and other considerations that must be taken into account when going through such a delicate process.
The most sensible thing to do is to weigh all the options and decide rationally if incorporating can be the right move for your small business.
About the Author
Nicola Clothier is CEO of Accurity GmbH, a Swiss based employment service provider. Nicola has an Honours degree in English Literature from Stirling University and more than 20 years’ experience in Swiss employment, and personnel leasing up to executive level throughout Europe.