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The benefits (or otherwise) of operating a business through a limited company remains one of the most important decisions affecting an owner-managed business.

As accountants, our key knowledge revolves around the tax implications of such a decision, but you certainly cannot ignore the legal distinction. Here the main benefit of being a company is the limited liability protection that this creates. In simple terms (and legal advice should be sought on this), a business owner is protected from business failings if the business is a limited company. Although this is not always the case if criminal activity is involved, for example, a company director will not typically be held responsible for actions carried out in the name of the company. This is different to a sole trader, who would be personally liable for any debts or other liabilities of the business.

This risk can be mitigated by taking appropriate insurance. However, it can be accentuated in the case of a partnership (effectively a sole trade business with 2 or more proprietors) as here the individual partners may be jointly liable for the actions of their fellow partners. In other words an ‘innocent’ party may have to personally bear the cost of the negligent actions of his business partner. If this is a genuine risk, a form of partnership known as a limited liability partnership or LLP is recommended, as it affords the same legal protections as a company whilst the individuals are taxed in the same way as a more conventional partnership.

Traditionally, from a tax perspective, the optimum model was to operate as a sole trader during the early development of a business. This is because losses can be offset against other income, stretching back over 4 years. Once the business was established and profitable a switch to a limited company was often recommended, not only because of the increased legal risks, but because of the tax benefits. Unfortunately the tax benefits have been eroded by a number of rule changes, notably around goodwill on incorporation and the introduction of the dividend tax in April 2016.

Whilst the ‘no brainer’ tax benefits of incorporation have gone it is still often beneficial from a tax point of view to operate as a limited company. Firstly, until high levels of income per business owner are achieved (say £100k) there is a tax saving in operating as a limited company. This does, however, phase out and actually become a disadvantage at higher rates of income because of the differing rates of national insurance and tax on dividends. Secondly, the tax rates paid on funds left in the business (for example to be used for investment in the business) are lower in limited companies than in sole trade or partnership businesses.

All cases are unique and there is no one-size fits all approach to this. We therefore recommend early and detailed discussions on the subject to ensure that the best trading structure is chosen. Whilst a trading structure can always be changed, this can be complex and involve dealing with a number of different people (lawyers, bankers, insurers, clients, suppliers etc) and therefore thinking first and selecting the right approach from the start is by far the most sensible approach.

The first step is to get some advice and we’d be more than willing to help. Get in touch and we can explore the options open to you.