Many clients when they start a business rush to form a company, and many farmers have also followed the same path in recent years. But is this the correct decision?
A company is a separate legal entity. When a company is formed a list of shareholders and directors are listed on Companies House.
The directors oversee the management of the company and the shareholders are the owners. For most family-run companies these are usually the same people.
This generally has little or no impact on the day-to-day running of a company. However, some new directors/shareholders fall into the trap of believing the company assets are theirs to do with them as they please. The assets belong to the company, which is a separate legal entity from the shareholders/directors.
If a director borrows money from the company, it is recorded in the director’s loan account. If the money is still owed within nine months of the end of your corporation tax accounting period, the company must pay S455 tax on the overdrawn balance of 32.5%. This is to stop directors taking money from a company and simply pocketing it.
If a shareholder wishes to receive a divided from a company, there must be enough profits built up in the profit-and-loss reserve account. So, if a company has £100,000 in the bank account but has lost money over its lifetime, the shareholders are not allowed to receive a dividend. This is to stop rogue company owners asking bank/investors to put money into their company and then simply taking all the money and making off with it.
These are two examples of the rules governing companies. There are many more and they are there to protect the shareholder, directors and investors.
Limited liability
Many people form a company to avail of limited liability protection. If a company is sued for £100,000 (and it is not covered by an insurance policy) and there is only £20,000 of assets in the company, what options has the director?
They can close the company – the £20,000 assets will go to pay the claim and the remaining £80,000 difference will never be paid. If they continue to trade with the company – the directors (not the shareholders) will be personally held liable for any further losses incurred by the company.
So, there is strong protection for shareholders and directors. However, if a major event occurs, and the company is no longer able to meet its liabilities, directors should seek professional advice.
Tax
When compared with operating as a sole trader, a company can become a very tax-efficient vehicle once profits reach a certain level (19% tax as opposed to 40%).
If a business is being prepared to be sold, it may be worth incorporating to avail of entrepreneur’s relief.
Again, professional advice should be sought.
Cash extraction
While the corporation tax rate is low compared with a sole trader, there is the key issue of cash extraction.
A sole trader owns all the money or assets in the business, so they can spend the money as they like. As a company is a separate legal entity the shareholders/directors cannot simply remove the assets. Cash extraction must be planned and done in a legal way for example, by:
Repaying director loans (if there are any).Paying interest on director loans (very popular as the directors avoid National Insurance Contribution payments).Contributions to a director pension.Pay as you earn (payroll).Dividends.Dividends
This is a payment out of the retained profits of a company and made payable to the shareholders. The dividend payment is liable to personal tax of the person receiving the dividend.
For taxpayers in the basic rate band (up to £33,500), it is 7.5%For taxpayers in the upper rate band (£33,501 to £150,000), it is 32.5%For many people, forming a company is the correct thing to do. However, for others, it is not advisable as there is no taxation benefits, but increased administration costs, increased governance and more rules.
Speak to a chartered accountant and discuss the pros and cons of the decision.
Please note the advice given above is very general and cannot not be relied upon as each individual business case would need to be assessed. MCA Chartered Accountants cannot accept responsibility for decisions based upon this article.
Many clients when they start a business rush to form a company, and many farmers have also followed the same path in recent years. But is this the correct decision?
A company is a separate legal entity. When a company is formed a list of shareholders and directors are listed on Companies House.
The directors oversee the management of the company and the shareholders are the owners. For most family-run companies these are usually the same people.
This generally has little or no impact on the day-to-day running of a company. However, some new directors/shareholders fall into the trap of believing the company assets are theirs to do with them as they please. The assets belong to the company, which is a separate legal entity from the shareholders/directors.
If a director borrows money from the company, it is recorded in the director’s loan account. If the money is still owed within nine months of the end of your corporation tax accounting period, the company must pay S455 tax on the overdrawn balance of 32.5%. This is to stop directors taking money from a company and simply pocketing it.
If a shareholder wishes to receive a divided from a company, there must be enough profits built up in the profit-and-loss reserve account. So, if a company has £100,000 in the bank account but has lost money over its lifetime, the shareholders are not allowed to receive a dividend. This is to stop rogue company owners asking bank/investors to put money into their company and then simply taking all the money and making off with it.
These are two examples of the rules governing companies. There are many more and they are there to protect the shareholder, directors and investors.
Limited liability
Many people form a company to avail of limited liability protection. If a company is sued for £100,000 (and it is not covered by an insurance policy) and there is only £20,000 of assets in the company, what options has the director?
They can close the company – the £20,000 assets will go to pay the claim and the remaining £80,000 difference will never be paid. If they continue to trade with the company – the directors (not the shareholders) will be personally held liable for any further losses incurred by the company.
So, there is strong protection for shareholders and directors. However, if a major event occurs, and the company is no longer able to meet its liabilities, directors should seek professional advice.
Tax
When compared with operating as a sole trader, a company can become a very tax-efficient vehicle once profits reach a certain level (19% tax as opposed to 40%).
If a business is being prepared to be sold, it may be worth incorporating to avail of entrepreneur’s relief.
Again, professional advice should be sought.
Cash extraction
While the corporation tax rate is low compared with a sole trader, there is the key issue of cash extraction.
A sole trader owns all the money or assets in the business, so they can spend the money as they like. As a company is a separate legal entity the shareholders/directors cannot simply remove the assets. Cash extraction must be planned and done in a legal way for example, by:
Repaying director loans (if there are any).Paying interest on director loans (very popular as the directors avoid National Insurance Contribution payments).Contributions to a director pension.Pay as you earn (payroll).Dividends.Dividends
This is a payment out of the retained profits of a company and made payable to the shareholders. The dividend payment is liable to personal tax of the person receiving the dividend.
For taxpayers in the basic rate band (up to £33,500), it is 7.5%For taxpayers in the upper rate band (£33,501 to £150,000), it is 32.5%For many people, forming a company is the correct thing to do. However, for others, it is not advisable as there is no taxation benefits, but increased administration costs, increased governance and more rules.
Speak to a chartered accountant and discuss the pros and cons of the decision.
Please note the advice given above is very general and cannot not be relied upon as each individual business case would need to be assessed. MCA Chartered Accountants cannot accept responsibility for decisions based upon this article.
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