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September 19, 2023

Tax Tips for Incorporating your Business

Thinking of incorporating your business?

Firstly, what does incorporation mean? This is when you form a new company or when an existing business chooses to become a company. For example, an existing sole trader or LLP may instead wish to trade via a company and therefore choose to incorporate their existing business.

Why would you look to incorporate your existing business? Here at PD Tax we have helped numerous clients to incorporate their businesses and here are some tax and other tips to consider when thinking of incorporating:

  • Sell or Gift to Company? Generally, there are two ways to incorporate a business; either by selling or gifting the assets of the existing business to the company. Both will have tax implications and so should be considered carefully before proceeding. Particular care should be taken to ensure the necessary beneficial elections are made, and consideration is given to the implications that could arise on the Directors Loan Account.
  • Incorporation Relief – Should any gains arise on the transfer to the newly incorporated company (such as the transfer of property or other assets), ordinarily a chargeable gain would arise on the disposal to the sole trade or members of the partnership. However, the chargeable gain could be wholly or partially deferred through claiming Incorporation Relief such that any Capital Gains Tax liability can be deferred. Tax advice should be sought to ensure any potential tax charges arising on incorporation are understood in full before proceeding.
  • Change of Tax Position – As a sole trader, you pay Income Tax and Class 2 and 4 National Insurance Contributions (“NICs”) on any income received.  Upon Incorporation, Class 2 and 4 NICs are no longer payable by the individual sole trader or partner and instead Class 1 NICs will be due by both the individual and the company. The shareholder will continue to pay Income Tax. Tax efficient methods can be used to mitigate NICs and Income Tax liabilities using a company (see below).
  • To Transfer or not to Transfer? If any property is being transferred to the company, a liability to Stamp Duty Land Tax could arise for the company. This could be mitigated by not transferring the land to the company, which could provide an alternative method of income for the individual (although this should be carefully considered due to Business Asset Disposal restrictions for future disposals (see below)).
  • However, this would prevent Incorporation Relief from being claimed so this should be considered carefully, especially if the SDLT saving is insignificant – have to think about the commerciality! If you have a mortgage on the property, you need to check whether the lender will be happy for the new company to take on the mortgage – we recommend speaking to your mortgage advisor on this point.
  • Limited Liability – A sole trader is liable for all debts in the business, leaving their personal assets at risk. Whereas a shareholder is only responsible for debts to the extent of the capital introduced by them. There are some instances where this ‘veil’ can be lifted (e.g. breach of duty of care) or this might not be available where personal guarantees are required from creditors/lenders. Legal advice should be sought on this position before incorporation.
  • Goodwill –  Corporation Tax relief is restricted for Goodwill in a company and could therefore have a impact on the costs to the business. Tax advice should be sought on this position before incorporation.
  • Capital Allowances – Incorporation of the business will result in balancing adjustments arising on the transfer of certain fixed assets and Writing Down Allowances, Annual Investment Allowance (“AIA”) and First Year Allowances are not available. AIA cannot be claimed on the assets transferred to the company. Elections can be made to avoid these balancing adjustments arising.
  • Tax Efficient Methods of Extracting Funds – There are additional methods of extracting funds from a company include:
  • Payment of dividends which can be more tax efficient than receiving a salary;
  • Charging rent to the company for use of the premises – please note that this will restrict Business Asset Disposal Relief in the future;
  • Directors Loan Account – charging interest on the loan made to the company, thereby taking advantage of personal savings allowance.
  • Bringing in the family to the business – as long as pay is reasonable and they are actually contributing to the business!
  • VAT Mitigation - VAT can be mitigated and not charged where there is a ‘transfer of a business as a going concern’ – An option to tax could prevent this so also best getting tax advice here!
  • Don’t forget to Notify! – The new company will need to notify HMRC that it has become chargeable to Corporation tax within three months of starting to trade so stick the deadline in the diary!
  • Increased Compliance – There are increased compliance requirements for companies that need to be dealt with that sole traders are not required to do, including filing accounts and confirmation statements with Companies House.

If you have any queries on any of the information in this article, or need assistance with incorporating your business, please contact a member of the team to see how we can help.

Disclaimer: This article is for general information only and is not intended to constitute individual advice. It is recommended that you seek independent tax advice before incorporating your business.

Contact us today to discuss your tax requirements.
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