In the context of tax implications, it is very important to consider as to which business structure will give the best returns: sole trader, partnership between two individuals, limited company or a limited liability partnership.
The answer to the question, “should I form a limited company’, is a difficult one as every situation is different and is controlled by many factors such as NICs, tax implications, profitability, the market trends, the risk involved, administrative policies, rate of growth, etc., among others.
The sole trader model is a preferred model in the first few years because of fewer administrative obligations and lenient use of funds as compared to when functioning in an incorporated environment.
Any company is mainly regulated by tax and company laws. This article aims to discuss the pros and cons of incorporating a business as a limited company.
Advantages of Incorporation
A few advantages of forming a limited company are listed below:
- Liability is limited in that the shareholders need not invest more money if they have already paid for the shares. The directors have to provide guarantees for any loans that may be taken for the business.
- The company is allowed to own property, file lawsuits and be sued against as well.
- The assets of the company can be secured for the purpose of a loan from the bank; this is likely to be a larger amount when compared to securing assets of a sole trader or partnership form of business.
- External investors can avail of tax breaks by investing in the company through specialized schemes.
- Shareholders can be paid in the form of dividends on the basis of strict company law formalities.
- The directors of the company are not bound by the national minimum wage law.
- A corporate status commands more respect for the business.
- A company has the provision to establish a pension scheme.
- Employee stock options may be provided to increase their commitment and interest in the company.
Disadvantages of Incorporation
Listed below are a few disadvantages with the limited company model of business:
- There are legal and administrative costs involved when forming a company.
- Existing clients and service providers must be informed in case the status of the company is changed to a limited business structure.
- Annual accounts must be maintained in compliance with the Companies Act. In some cases, an annual statutory audit is compulsory. This is more complicated in the case of a limited company when compared to other models.
- The annual accounts of the company must be filed under the public view of the Registrar of Companies. Failure to pay on time carries a severe penalty.
- Funds withdrawn from the company invites tax liabilities. This is not the case in unincorporated business models where the owners can either introduce or withdraw funds as and when they wish without any tax implications.
- Trading losses can be easily dealt with in the case of a limited company.
- The director of a limited company is more at risk of having criminal proceedings initiated in case of default of submission of accounts or violating insolvency rules.
However, the individual has to finally decide on the business structure that would be most suitable for him/her under the prevailing circumstances.