Carousel_Arrow Chat icon_cookie IHT_trust_wills IR35 Combined Shape 2 Group 10 Login Mobile Menu Share Share Email SubMenuMobile Group 9 VAT View_Gallery View_List capital_allow Triangle 2 Copy Close construction cyberpro employment_tax_shares emplyer_solutions entrepreneurs_corps fee_protect Group 7 grant_fund Group i_Clock i_Consult i_Done i_Eligibility_Tick i_Enter i_Filter i_HMRC i_Negative i_Play i_Plus i_Reset i_Support_Legal i_Support_TaxDesk i_Support_VAT i_Tick noun_marketing_1872083 noun_online_2126759 i_download i_meet Group Copy 24 Group 18 noun_electrical_1240755 copy noun_Technology_2125422 noun_Science_2031115 i_tick_bullet_block international_tax patent_box private_client property_sdlt r_and_d reliefs_incentives Search specialist_tax status tax_indemnity valuation YouTube
Markel Tax

15 Jun 2020

Incorporation – Limiting Liabilities while Expanding Opportunities

Start-up costs for any business can be onerous, and it is natural for entrepreneurs to postpone the idea of incorporation during a time when they are concentrating on getting the business off the ground. Becoming a limited company is perceived as something which can come later, when the business has grown and become more established.

This could prove a potentially costly decision!

Ironically, the early days, months and years in the life of a can be the ones which yield the most in terms of incentives and reliefs, especially with regard to tax. Should the business be concerned with an innovative process or product, or involve an aspect of development to its work, then this early period of trading may prove to be the most valuable in terms of qualifying for R&D tax relief, for example.

However, many such reliefs relate to corporation tax – that is to say, they can reduce, eliminate or delay the amount of tax a company pays on its taxable profits. While this outcome alone can be a great incentive to incorporate, this is a step which many business owners find daunting, or simply believe to be unnecessary.

It certainly pays to weigh up the consequences of making one’s business into a limited company – every personal and commercial situation is unique, and the advice of a reputable adviser should be sought to ensure that one’s particular financial situation is considered fully prior to the decision to incorporate is taken. We have set out below some considerations for those in that very position – and we are fully aware of the need to look at the situation as a whole, not to be driven by a short-term benefit.

Status and limited liability

The status of a limited company provides, rightly or wrongly, a perceived gravitas within the market place. It implies an established nature of a business, and can give new customers confidence that they are dealing with those in the know.

Furthermore, many larger companies themselves concentrate on working with other corporate customers, so if you intend to grow your client base and your company as a whole, then incorporation from the start is clearly worthwhile.

At the other end of the process, should the business be considering an exit strategy, then bear in mind that third party potential purchasers are likely to find company status more attractive from a due diligence standpoint, as a company’s financial and compliance history can then be seen independently from that of its shareholders.

Independence is also a contributing factor in that a company, as a standalone legal entity in its own right, can offer its shareholders a level of limited liability protection.

Corporation tax  

As mentioned above, a range of incentives and reliefs exists to reward and benefit limited companies by reducing their overall tax burden.

Companies pay tax at a current rate of 19%, significantly lower than the potential rate of 45% which applies to a sole trader, or to individuals operating via a partnership. Furthermore, companies are not liable for capital gains tax at the same rates as individuals; rather, any gains from the sale of assets from a company are taxed at corporation tax rates. This can prove tax-effective in a number of situations, so well worth a discussion with an adviser.

Pluses and minuses exist in terms of ultimate profit extraction from companies and unincorporated businesses, but again, this is an area in which careful planning and timing can keep a range of taxes to a minimum.

Passing equity to family members and rewarding key employees

It can prove more straightforward to pass on shares in a company to family members as part of a succession plan. Similarly, an equity stake in a company can be used to reward key employees tax effectively, by means of an approved share scheme such as an Enterprise Management Incentive (EMI) plan. Such schemes can only be used by companies, and are not available to unincorporated businesses.

Research and Development (R&D) relief

As mentioned above, this is a corporation tax relief designed to reward companies showing a commitment to making technological advances within their respective sectors. This can apply to a wide range of industries and processes, and is not limited to those companies which operate only within hi-tech or scientific environments.

Companies incurring expenditure on qualifying R&D may be entitled to claim enhanced tax deductions for revenue expenditure, along with 100% capital allowances on any R&D capital expenditure. 

This essentially translates to a reduction in corporation tax payable, the creation of corporation tax losses which can be carried forwards as an asset to reduce future profits, or even the creation of tax credits, payable to the company from HMRC.  The latter can arise when a company is loss-making but is in the process of developing a product or a process in order to make an advance in its area of expertise. This is a common situation for companies which are investing in R&D, and tax credits at this stage can provide a vital cash flow boost.

There are two different schemes within the R&D legislation, which reward small or medium sized companies at a higher rate than those designated as large. Markel Tax has a strong team of experienced tax advisers, many with science and technology backgrounds, who can advise on specific scenarios, and it is always worth a brief telephone conversation to discuss a company’s potential for such reliefs.

Remuneration

The manner in which working shareholders extract funds from a company can impact the level of tax payable, and also impact the deductions within the company itself.

Where income is extracted as remuneration, it is taxed via PAYE by the company as follows:

  • Income tax deducted from individual

  • Class 1 National Insurance deducted from individual

  • Secondary Class 1 National Insurance paid by the company on the amount of the employee’s remuneration - although it would be entitled to a corporation tax deduction.

 

Basic Rate Employees:

Employees whose income falls into the basic rate band suffer tax at an effective rate of 32%
20% income tax and 12% Class 1 Primary National Insurance.

Higher Rate Employees:

Employees whose income falls into the higher rate band suffer tax at an effective rate of 42% -
40% income tax and only 2% Class 1 Primary National Insurance.

Furthermore, additional rate taxpayers suffer tax on the bonus payment at an effective rate of 47%.

Dividends

The payment of dividends has become the established way for shareholders to extract funds, as the overall income tax exposure is lower for the individual, and the payment of dividends does not necessitate a National Insurance charge at either shareholder or company level.

Dividends of up to £2,000 can be paid each year tax free, and are taxed thereafter at the following rates:

  • 7.5% - when within the individual’s basic rate band

  • 32.5% - when within the individual’s higher rate band

  • 38.1% - when above the individual’s higher rate band

The most tax efficient option for shareholders to extract profits is often to combine both methods -remuneration using personal allowances, enhanced by dividend payments.

All planning with regard to dividends is naturally based on the assumption that the company has sufficient distributable reserves, and the dividends v salary question is again one which needs careful consideration and detailed advice which is specific to the individuals concerned.

Incorporation – a summary

While we have outlined above some of the issues facing a business on incorporation, and the immediate and long-lasting benefits of becoming a limited company, it must be pointed out that incorporating an established business in order perhaps to lock into R&D relief or to issue shares may also give rise to certain tax exposures. Again, these can be discussed in detail with an adviser as and when they become applicable to a particular set of circumstances. For completeness, we have highlighted them below:

  • Disposal of assets to a limited company can trigger a potential chargeable gain based on market values, as the parties involved will be connected.

  • As with corporation tax, however, there are several capital gains tax (CGT) reliefs which exist to minimise a company’s liabilities – s 162 TCGA 1992 Rollover Relief, for example, or s 165 TCGA 1992 Gift Relief.

  • The original unincorporated business will cease on incorporation, so aspects such as overlap profits and capital allowances balancing adjustments need to be considered.

  • When a physical property is being transferred across to a company, stamp duty land tax (SDLT) based on market values could arise.

All the potential costs and issues outlined above need to be assessed, along with ongoing benefits of operating through a company structure. It may be that incorporation is not a step every sole trader or partnership would wish to take. However, with the incentives, reliefs and potential to minimise the tax burden all there for the taking, it is an opportunity every unincorporated business should most definitely explore.

For further information and support with these or any other tax-related issues, please contact
Martin Mann, Director of Owner Managed Businesses and 
Justine Dignam, Director of Tax Incentives and Reliefs or call 0333 920 5708

Our COVID-19 Hub contains a range of information and resources to best support our clients during this difficult time. To receive the latest news and insights by email sign-up here.

Tagged HMRC R&D tax relief R&D tax relief
Next article in series

15 Jun 2020

Capital Allowances for Leaseholders