THE ADVANTAGES AND DISADVANTAGES

OF TRADING THROUGH A LIMITED COMPANY

Introduction
Whether you are starting up in business for the first time, or are contemplating changing your business vehicle from that of a sole trader or partnership to a limited company, it is important that you are given a balanced view as to the advantages and disadvantages of trading through a limited company. Set out below is a summary of the points you should be considering. If you require any further advice, please do not hesitate to contact us.

The advantages

Limited liability
A limited company is regarded in law as a separate legal personality, distinct from its shareholders. For this reason, if the company for any reason is unable to meet its liabilities, the shareholders will only be personally liable for the unpaid amount of their shares. If the shares are fully paid, then the shareholder cannot be asked to pay anything further.

It is therefore, strictly speaking, incorrect to say that a company has limited liability; it is the shareholders whose liability is limited - up to the unpaid amount of their shares.

This situation must be contrasted with the personal liability of a sole trader or a partner in a partnership (with the exception of a partner with limited liability or in the case of a Limited Liability Partnership (LLP)). In these cases the sole trader or partner may be personally liable for any debts which the business is unable to meet.

As noted above, there may be instances when personal liability cannot be limited. This situation usually affects directors who may be personally liable if they have acted fraudulently of negligently. In particular, you should be aware of the personal liability which can accrue to directors if their company trades whilst it is insolvent.

Whilst the limitation of liability can prove attractive you should be aware that in certain cases, notably when dealing with banks or other financial organisations, personal guarantees may be requested from the directors, and/or shareholders. This may then negate this particular advantage.

Taxation
You should be aware that companies, as opposed to sole traders and partnerships, are subject to different taxation regimes.

As we are all aware a company will pay corporation tax on both its profits and capital gains, whereas sole traders and partnerships pay income tax on profits and capital gains tax on any capital gains.

There are three fundamental differences between corporation tax and income tax/capital gains tax:
1 The method of assessment.
2 The tax rates.
3 The timing of the payments.

Within our present taxation regime there is a general rule which is that the more profitable a business, the more advantageous it becomes to pay corporation tax, as this carries a lower rate than the personal tax rates.

In addition to the above points it is also important that the timing of the formation is considered when a sole trader or partnership is being transferred into a company. This is due to the rules relating to years of cessation.

Perpetual succession
This is an important advantage for a company. As has already been mentioned, a company is separate from its owners (ie shareholders) and its managers (ie directors). For this reason if shareholders or directors leave or die the company continues. This would not be the case for a sole trader. If the sole trader leaves or dies so does the business, unless someone else is willing to take it over.

It is also easier to transfer ownership in a company, simply by transferring the shares from the outgoing shareholder to the incoming shareholder. Similarly, it is relatively easy to introduce additional owners by issuing new shares. This can be more complex with other types of business.

Financing
Companies have a distinct advantage over sole traders and partnerships in that they are able to offer both fixed and floating charges to secure any loans. A sole trader or partnership (excluding LLPs) cannot offer floating charges.

In addition, outside investors may be encouraged to invest in companies through such schemes as the Enterprise Investment Scheme or a Venture Capital Trust. Such schemes are not available to sole traders or partnerships.

Separation of management from owners
There will be a number of instances where some or all of the owners of the company (ie the shareholders) will play no part in the day-to-day running and management of the company. This presents no problems with a company but is not usually possible in most unincorporated businesses.

Group structures
By creating group structures involving a number of companies, there can be advantages. For example, if each company within the group operates a different type of business, then if one company's business fails it will not necessarily drag down the other companies.

There can also be advantages in relation to tax relief which can accrue to groups.

Restructuring
There may be reasons why a company needs to be re-structured from time to time. For example, authorised share capital may need to be increased, new classes of shares may be introduced, or share capital sub-divided. All of these can be achieved relatively easily with a company but may prove more problematical with, for example, a partnership.

Kudos
Rightly or wrongly, a number of people wish to trade through a company because they feel this gives greater status and an impression of stability. This is especially so with public companies. Whether or not this is the case will depend on the circumstances, but such a reason should rarely be the sole reason for trading through a limited company.

The disadvantages
Administration
Companies are controlled in the main by legislation and specifically through the Companies Act 1985. There are strict rules as to the disclosure of information, filing requirements, accounts preparation and the maintenance of records. These can be time consuming and, if carried out by third parties, can be more expensive than the administration required for other types of business.

In addition, it may be more expensive to start up a limited company, as formation and other professional fees will have to be paid.

If the company has to have a statutory audit carried out then audit fees will be payable.

The cost of preparing accounts can be greater with a company as the formatting of the accounts is more complex.

A company must also prepare and file an annual return each year. This is not a particularly onerous task and the filing fee is only £15, but nevertheless this job must be undertaken.

The Companies Act contains strict rules regarding the timing of the filing of accounts and hefty penalties are imposed if a company is just one day late in filing.

National Insurance
In addition to taxation considerations, one must also have regard to National Insurance Contributions. You should be aware that if the company operates a payroll scheme, then, in addition to PAYE, it must also deduct both employer's and employees' National Insurance.

Company names
Whereas a sole trader or partnership (but not an LLP) can start trading using any name - the rules are more stringent in relation to the name of a company.

Remember that whilst you can choose any name, you must be wary of passing off actions and/or infringements of trade marks.

Personal service companies
Special consideration should be given to what are termed as "personal service companies". A personal service company is a company which earns income from supplying the personal services of its proprietor to other businesses in circumstances where the proprietor would have been taxed as an employee if he or she had been engaged directly by the client business rather than through the company

Personal service companies are used by a number of individuals, especially those engaged in IT work and design consultancy.

We would advise you to think very carefully before forming such companies for individuals, as they may be open to attack from the Inland Revenue.

Summary
The choice as to which type of vehicle to use to conduct business is a difficult one and will depend on a number of factors. Often a particular vehicle will not suit every need and it is sometimes a question of finding "the best fit". However, careful thought should be given before deciding on a particular vehicle, be it an unincorporated business or a company, as it may prove difficult and at times expensive to reverse the decision once it has been made. Please consult us before you make any irreversible decisions.