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Tax implications of incorporating your sole trader business

Tax implications of incorporating your sole trader business

You can transfer your existing sole trader business to a new limited company. This is called incorporation and it is choice you can make for tax or strategic reasons.

Even if there are huge tax advantages when incorporating, you can choose to continue doing business as a sole trader instead. While this blog considers the tax implications of incorporation, the decision should not rely solely on the tax reasons.

Why would you incorporate your sole trader business?

  1. Corporation tax paid by limited companies is at a fixed percentage of 19% (going down to 17% from April 2020) whereas the highest rate of income tax paid by sole traders is 45%.
  2. Company “profits” can be extracted by an owner-manager using a combination of salary, dividend, rent, interest and tangible benefits making the remuneration package more tax efficient that sole trader profits which are only taxed as income tax.
  3. Using a company, a salary can be paid to secure basic social security benefits and still avoid National Insurance Contributions (NICs). We discussed this in a previous blog.
  4. Profits can be retained in the company and therefore not suffer higher rate income tax.
  5. You can gift your spouse or partner shares in the company and split the company’s income to take advantage of your combined tax allowances.
  6. You may be able to cash in the capital value of your business. Capital assets including goodwill can be sold to your new company for cash, shares or deferred consideration.
  7. Capital Gains Tax (CGT) reliefs may ensure that you pay little or no CGT on the transfer of your business to the company.
  8. Entrepreneurs’ Relief (ER) does not apply to disposals of goodwill made on or after 3 December 2014 on incorporation. However, ER continues to apply to the disposal of other assets such as land and property.

What are the non-tax factors to consider when incorporating your sole trader business?

  1. Not all businesses are suitable to be run through a company mainly due to strategic reasons.
  2. A limited company is still regarded by many people as being evidence of a “superior” business to that of a sole trader.
  3. The needs, aspirations and tax positions of the owner-manager may change.
  4. An owner-manager may be asked to personally guarantee a company’s bank borrowing in the short-term, and so may still retain personal liability to the bank if the company defaults. However, there are alternative funding solutions which may give access to credit without the use of personal guarantees.

Would you like to learn more about tax-strategies?

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