Benefits of Incorporation

There are two key benefits to incorporation:

a lower effective rate of tax on profits, corporation tax being a lower rate than income tax and class 2/4 NIC

flexibility over income in respect of:

  • Timing of remuneration
  • Form of remuneration

On a simple comparison, the difference on tax rates for retained profits between companies and unincorporated businesses may be up to 28% (ie 19% main rate of corporation tax versus 47% higher rate of income tax and Class 4 NICs combined). 

To the extent that profits are withdrawn from the company, at the current levels of income, the tax burden comparing partnership to limited company are unlikely to differ hugely, however to the extent that annual profit is retained in the business, annual savings accrue.

Employer pension contributions can be made through the company saving national insurance.

Summary of tax implications of incorporation

Income tax

Income tax implications of incorporation include:

the unincorporated trade ceases and so the closing year rules apply

any overlap profits will be released and may generate a loss

the partners as directors of the company become liable to tax on benefits in kind in respect of private use of business assets 

Capital gains tax

Capital gains tax implications of incorporation include:

the sole trader will be treated as disposing of chargeable assets, in this case goodwill. 

it may well be beneficial to pay tax on transfers of business goodwill at the main rate of capital gains tax which is 20%, effectively advance paying tax on future income at 20% rather than 40 or 45%.  The cash flow implication of this may be mitigated by the reduction on self assessment income tax payments, this would need to be modelled out.

Alternatively if the upfront tax cost of incorporation for value as noted above is too high, but there are still benefits in incorporating, incorporation relief may be available to defer the gains against the base cost of the shares in the company or gift relief may be claimed. 

Other issues to consider on incorporation

Other corporate reliefs

Companies can claim R&D tax credit relief where appropriate, see http://www.hmrc.gov.uk/gds/cird/attachments/rdsimpleguide.pdf , partnerships cannot. 

Share option/share incentive schemes

Companies can introduce share option / share incentive schemes to incentivise and retain key employees. Such schemes are not available to partnerships.