The Pros and Cons of being a Limited Company

All businesses need to decide the best medium for that business, such as being a partnership/sole trader or say a limited company.

Particularly when I advise small to medium sized businesses I am surprised by the number of these businesses that are not incorporated (i.e. not a limited company) and have not properly considered whether to become incorporated.  So what are the pros and cons of being a limited company?

The Pros

1. The main advantage is the limited liability status of the company.  If the company gets into financial trouble, save for certain exceptions, the owners’ liability is limited to the extent of their shareholding (e.g. a £1 share) and their personal assets are safe from a claim from the company’s creditors.  The advantage is often diminished where banks or other sources of credit insist on the owners giving personal guarantees.

2. Quite often the word “limited” after a business name may provide enhanced status in the eyes of bankers, suppliers, potential customers and can often help to gain new contracts.

3. There can be significant tax advantages.  A limited company pays tax on its profits, and its directors are taxed on what they receive in remuneration from the company.  A partnership on the other hand is not taxed in its own right as a company is (as it is not a separate legal entity).  Instead each partner is taxed on his or her share of the profits, irrespective of how much they have taken out of the business.

Let’s say for example the business makes a profit of £200,000 and pays “salaries” of say £100,000 in total to its two owners.  In the case of a limited company, it would be taxed at 21% on the sum of £100,000 (profit less salaries), and the directors would be taxed at 40% on the salaries of £50,000 each.  The total tax payable would be £61,000 (£21,000 plus £40,000).  In the case of a partnership, the partners would be taxed at 40% on all of the sum of £200,000, even though only £100,000 is paid out in salaries/drawings.  The total tax liability would therefore be £80,000.

4. Furthermore there are often tax advantages from being a limited company as owners can pay themselves a nominal salary plus substantial dividends at lower rates of tax.  For example you might only have to pay 10% tax on dividends.

The Cons

1. I think the main disadvantage is the extra administration burdens that can arise.  As a limited company you have to file accounts and information at Companies House, and often these involve a significant cost in terms of accountants’ fees etc.  However usually the tax advantages outweigh these disadvantages.

2. There can be tax disadvantages in being a limited company and some of these include a less favourable treatment of trading losses that may arise, reduced IHT relief for assets owned personally but used by the company, e.g. premises. Particular care also needs to be taken when there is a prospect that the business could be sold within 2 or 3 years.

If you need advice on whether your business should be a limited company or not then please contact Daven Naghen on 01775 722261 or email daven.naghen@maplessolicitors.com or Gemma Mayer on 01775 722261 or email gemma.mayer@maplessolicitors.com