Being a limited company can be awesome for tax saving in the right circumstances. If you are already a sole trader business, then turning into a limited company creates opportunities to really maximise your tax savings.
Changing from a sole trader to a limited company also has potential pitfalls, and you could potentially get caught out tax-wise.
This article highlights some issues you may not have thought about, rather than to try and instruct you on exactly what to do. This is because each area could be a blog in itself! So, we wanted to give you some points to think on so you can:
- Avoid some of the key traps
- Spot some of the opportunities
Why might you want to incorporate?
This is briefly worth revisiting, as the answer for many owners is ‘To save tax!’
As a well-run limited company, you can:
- Enjoy generally lower rates of taxes
- Potentially split income with another
- Have access to other favourable tax rules
- Gain a certain level of protection as a company (known as ‘limited liability’)
The most common downside is that you usually need help (or extra help) from an accountant for the annul filing. You also need to be more stringent in your record-keeping.
For more information on this, see our blog on Should I be a limited company?
What will you transfer?
You should consider various different aspects of your business when looking to turn yourself into a limited company, including:
- Monies owed by customers (‘Debtors’)
- Monies owed to suppliers (‘Creditors’)
- Business equipment
- Business property
- ‘Goodwill’ (i.e. the value of the business that isn’t anything above)
As you will likely be ‘connected’ with the new company so some of the items in the list may have to ‘disposed’ of as a result. These items must be disposed of at market value, i.e., what they would be worth if sold to an unconnected 3rd party.
Disposing of items without knowing the rules can land you with an unwelcome capital gains tax, income tax and/or stamp duty land tax bill. Each item could be treated differently depending on how you transfer it, so doing this properly can maximise your tax position.
The key tax traps
The key ‘tax traps’ to look out for are:
- Getting hit with a Capital Gains Tax bill relating to items like goodwill and property
- Getting hit with a Stamp Duty Land Tax bill relating to property (in the main)
- Getting hit with a large income tax bill relating to stock & equipment, in particular
- Not dealing with the VAT properly on transfer
- Not valuing the goodwill where there is some
Valuing the goodwill is particularly important. Your business may have a goodwill value, but failing to consider what this value might be could land you with a tax bill.
It’s not all bad – there are some key opportunities as well, such as being able in some scenarios to create a ‘director’s loan account’, which gives you a pot of money to draw down later tax free.
The detailed bit – tax reliefs
There are a few different tax reliefs you may use to help transfer items with a decent tax result. The two key ones are:
- Incorporation Relief (‘section 162’)
- Gift or Holdover Relief (‘section 165’)
Both of these reliefs tend to have the same effect where they apply. You can generally avoid a Capital Gains tax bill immediately when you transfer many of the assets. The ‘gain’ is then only taxed if you later sell those items.
These are detailed reliefs and have their own pros and cons. For example, Incorporation Relief requires that you transfer all assets to the new company, which might not be want you’d like to do. It also ‘locks’ the value of the business into your new shares, which again might not be ideal for your circumstances.
There are conditions on the VAT in which you may qualify as a ‘Transfer or a going concern’ . The rules are strict here, but when they apply make life fairly painless in terms of any tax bills.
If you have an existing business and are thinking of turning it into a limited company, take professional advice from an accountant who is experienced in these matters. It can save you a decent chunk of tax by using some of these reliefs, both now and in the future.
If you don’t have an accountant, or your accountant doesn’t have experience of changing from sole trader to limited company, we’d love a chat about how we can help.