A limited set of options
Chartered Accountant Ann Tilman outlines the pros and cons of becoming a limited company for sole traders.
Just consider, at a stroke the veil of incorporation turns sole trader Acme Qualitative Research into Acme Qualitative Research Limited. A small word but a massive step.
Its cheap and easy to buy a limited company. You have status as a director of a company. Your accountant can transfer your existing business assets into the new limited company, creating goodwill from your old business and enabling you to draw tax-free income from day one. You then pay all your profits out to yourself in dividends with no more tax to pay until you hit the 40% tax band.
You and the company are not the same legal entity. In theory you cannot be held personally liable (but when was the last time a market researcher was sued?) — unless you trade insolvently.
What could be simpler?
Will I save tax?
There are tax advantages in incorporation, but any tax saving will be reduced by additional professional fees — and could you cope with the added administrative burdens?
Researchers have to be very careful to segregate personal from business expenses, as the Revenue regards the former as a personal loan and taxes them accordingly.
Youll need to keep detailed mileage records for business use and charge the business at the authorized Revenue mileage rate to avoid being charged a material benefit in kind for your motor vehicle, whose expenses will not be allowed for tax purposes.
Youll also be paying corporation tax on your profits. As you take dividends out of the business you will be charged in a mind bogglingly complex calculation.
Of course, you will still need to complete your own personal tax return.
Whats the downside?
Taking all of your earnings out as dividends upsets your pension planning. Contributions to pension schemes are based on earnings. Once every five years you have to pay yourself a sensible annual salary upon which you base the next five years pension contributions.
This income, unfortunately, is subject to both employers and employees national insurance contributions and tax. It has to be paid under a Paye scheme, a monthly hassle in itself. As a rough guide, to have the same take home income for this basis year, you need to earn double that of a self-employed person.
Existing trade creditors may not be keen on trading with a new limited company with no credit record. They may not give you existing credit terms. This can affect cash flow.
You may have to give personal guarantees for business loans, thus negating the protection of the limited company.
Mortgage institutions may refuse a loan as they dont recognize dividend income as earnings.
Any more shocks?
You must have a Registered Office. You may use your office or your own home, but there may be covenants against this, or youll have to pay a third party for this service.
Statutory books have to be maintained and minutes need to be completed. You need professional assistance, at cost, for this.
Your accounts and an annual return have to be filed on public record with the Registrar of Companies. A basic set of limited company accounts can exceed eight pages. At present if you dont want everyone seeing your turnover and profits you can file abbreviated accounts, only about four pages, but at extra professional cost and this concession is being withdrawn.
You need to submit a corporation tax return along with accounts and corporation tax computation to the Inland Revenue annually.
All of the above returns need to be filed on a timely basis, with fines for missing filing deadlines.
It is common practice to treat your personal allowance as earned income, to avoid loss of your statutory rights. This is totally artificial, as you couldnt possibly live on this amount. Paye enquiry officers are quite bullish and you are open to attack for this and for paying yourself under the national minimum wage.
Opinions are divided about frequency of paying yourself dividends and the administration involved.
So what should I do?
It is much easier to set up a limited company than to get rid of it. There can be massive tax effects and professional and administrative costs of doing away with a limited company.
Always make a commercial decision and dont let taxation create an artificial situation that can damage the business itself.
Copyright © Association for Qualitative Research, 2005