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Advantages and disadvantages of limited company formation:

Advantages and disadvantages of limited company formation

Operating as a limited company is the one of the most popular business for all sizes and types of businesses. In order to register a company in UK, The business must be incorporated legally with the Companies House. Companies House is a government agency which is sponsored by Department of Business, Innovation and Skills. It operates as official registrar of the companies in Wales, England, Northern Ireland and Scotland.

When a limited company is incorporated, it is considered a separate individual by the law. A limited company is responsible for its own liabilities and debts. The company has to disclose some corporate information on the public records. Companies must also adhere to different reporting and filing requirement according to the Companies Act of 2006. They also have to pay 20% Corporation tax on their taxable income.

Both a for profit company which is limited by shares and a non-profit company which is limited by guarantee, enjoy many benefits which are not available to the sole traders. Operating as a sole trader is also a very popular structure for businesses of small and medium size. In fact it is the 2nd most popular type of business structure in the UK.

In a sole trader structure of business, the business is owned and operated by the same individual and he is himself liable for all the claims and debts. The person is also responsible for paying National Insurance Contributions and Income tax return on all the taxable income. The person has to file Self-Assessment tax return each year. There is no legal distinction between a person operating as a sole trader and his business.

The major differences between the two types of structures are tax efficiency, professional status, required administrative and filing responsibilities and financial liability. One should consider these factors carefully in order to determine which legal structure will give the most benefits to the business and the owner.

Limited Companies:

One or more people, called members are the owners of the private limited companies. The members of those companies which are limited by shares are referred to as ‘shareholders’. On the other hand members of those companies which are limited by guarantee are referred to as ‘guarantors’. The directors are responsible for managing the both types of companies.

However, large number of small companies are managed and owned by only one person who takes care of the roles of guarantor/shareholder as well as director. A limited company has a flexible nature, giving and opportunity to set up companies with multiple directors and members and an opportunity to appoint new people after formation.

Advantages of operating as a limited company:

The three main reasons of trading as a limited company are status, tax efficiency and limited liability.

  • Limited Liability: It is the biggest benefit of running your business as a limited company. In case the company goes in to financial difficulty, the assets and personal finances of shareholders are protected beyond value of their shareholding. This means that if a company is unable to pay debts, the shareholder will only have to contribute according to the nominal value of their shareholding. It can be as small as £ 1.

If you want to provide high value services or supply which can lead to liability claims and/or operate in public domain then limited liability is important. In such situations, your personal finances and assets are protected. Operating as a sole trader does not have this benefit.

  • Tax efficiency: More opportunity and great flexibility is offered by limited companies in the case of taxation on profits and on personal income. The profits of companies have a rate of 20% Corporation Tax. Before 1st April 2015, Corporation tax had two rates; if profits were £300,000 or above then the corporation tax was 20% and if the profits were £1,500,000 then the corporation tax was 21%. But not the rate is 20% regardless of the size of profit. On the other hand sole traders pay 20% income tax on their profits of £31,865 or above; 40% income tax if their profits are between £31,868 and £150,000; and the rate is 45% for profits above £150,000.

 The directors can keep their income level below the higher bands through taking remuneration in combination of dividends and salary. This results in more money being available for reinvestment or distribution among the shareholders and directors. Sole traders don’t have any such strategy to save tax.

  • Professional Status: A professional and corporate image is created by a limited company, thus boosting the value of business. More corporations and industries like to do business with companies, instead of sole traders. This is because limited companies are considered to be more established, credible and committed. Sense of security is also provided by limited liability to certain industry professions while choosing to use the services of new business or while investing.

Although operating as a limited company has greater administration costs and accounting requirements, requiring more attention and time, the professional and financial gains cover these drawbacks.

Disadvantages of operating as a limited company:

  • Must incorporate the company with Companies House.
  • Generally there are more costs to set up.
  • One cannot be a director of a company if he is disqualified director or un-discharged bankrupt.
  • There are certain restrictions with regard to the company name.
  • The information relating to the owner of the company and the company are displayed on public record.
  • There are more complex, time consuming accounting and administration requirements.
  • The accountancy costs are more expensive. A professional accountant might be required.
  • Withdrawal of money form companies can be difficult.

 Sole Trader:

Starting a sole trader business is quite easy. The administration and registration requirements are very simple and one can begin trading any time he likes. Operating as a sole trader does not require working alone and one can employ people to work for them. Ultimately the owner is personally and wholly liable for the business and the debts.

On the other hand as there is no legal distinction between the personal finance and the business finance of a sole trader, one does not have to go through a complex procedure in order to take money for personal use.

Responsibilities and Rights of sole traders:

  • Maintaining accurate accounting and business records – like that of costs, sales and expenses.
  • Unlimited liability – all the business claims and debts are the liability of the sole trader alone.
  • Completing Self-Assessment tax return annually for HMRC
  • Payment of Class 2 National Insurance every week or twice every year
  • Payment of income tax and Class 4 National Insurance on all profits of business.
  • Registering for VAT (value added tax), if it is expected that the earning will exceed threshold of £82,000 a year (2015-16)
  • Responsibility to register as employer (in case applicable).
  • Payment to employees through the PAYE.
  • Responsibility to adhere to requirements of health and safety related to workplace for employees.
  • In case one is planning to provide contract or a subcontract service to construction industry, He must register with CIS (Construction Industry Scheme)

Advantages of operating as a sole trader:

  • There is no requirement to register with the Companies House and there are no registration costs.
  • It is easy and quick to set up online via HMRC.
  • Usually, a small amount of capital is required to start the business.
  • The accounting requirements and paperwork are minimal in comparison to a limited company.
  • Either there are no accountancy costs or are very small.
  • The owner has the full control over the business.
  • The owner enjoys ownership of all the assets of the business.
  • Tax relief is available on all business expenses and purchases.
  • The owner can retain all profit after tax.
  • The details about the owner and his business are private.

Disadvantages of operating as a sole trader:

  • Unlimited liability – debts and liabilities of the business are owner’s debts and liabilities.
  • It can prove difficult to raise capital and to setup and grow business.
  • Only one person has to take all the responsibilities and decisions.
  • The owner has to pay income tax on all profit and it can be as high 45%
  • Owner is responsible for paying tax and National Insurance contributions.
  • Status – Generally sole traders seem to be smaller and less established compared to limited companies.
  • Certain companies may not deal with sole traders – Because it is considered risky.
  • It can prove to be difficult to manage work, take holidays or sick leaves.
  • Sole traders are not eligible for the Statutory Maternity Pay.
  • One cannot leave the money in business as a strategy to save tax – All money is subject to tax, in the same financial year it is earned.

 

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DaniDee2
DaniDee2

John Carter is a leading expert in the company formations industry. He has assisted countless business owners incorporate companies and is a font of knowledge when it comes to starting a company!

1 Comment

  1. Steve Jones says:

    All start-ups should at some point consider becoming a limited company if you are not already. A limited umbrella protects you and your business if anything financially bad was to happen. In a limited company your assets and liabilities are protected within the umbrella of the company. If for any reason you were to go into liquidation outstanding debts from creditors would not be paid by you as an individual. This is the best protection to have. Here are a list of the ins and outs of a limited company formation.

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