| Should
You Form a Limited Company
Tax changes have made it even more important to consider carefully,
when running a business, whether it is best to trade as:
We are often asked, 'Should I form a Limited Company?' The reality
is that there is no easy answer. Each situation has to be judged
individually. As well as the obvious issues of tax and national
insurance contributions (NICs), there are many other potentially
relevant factors, such as:
In the early years of a business, the privacy of operating as a
sole trader or partnership may be attractive. Business funds can
be used with fewer restrictions than in an incorporated environment.
However, we are considering here the features of a limited company.
A company is a completely separate legal entity subject to two main
areas of regulation - tax and company law. This planning guide looks
at some of the advantages and disadvantages of trading as a limited
company. Please do contact us if you want more specific help or
advice.
Possible advantages of incorporation
Potential disadvantages of incorporation
Conclusion
There is no doubt that recent developments and in particular the
introduction of the 19% tax charge on the first £10,000 of
profit have made trading as a limited company less attractive. However,
the tax regime applied to limited companies is quite complex, and
it is necessary to look beneath the media publicity attached to
the absence of NICs on dividends.
There can be no substitute for a detailed analysis, and we are
happy to help you in any way we can.
Do call us if you would like further help or advice on this subject.
Forming a Limited Company
Although you can set up a company using your own resources, it
is normally advisable to use a specialist formation agent. You first
need to decide on the following:
Incorporation procedures
You will need to complete the following forms:
Send the completed forms to Companies House with a cheque for
the necessary fee, and the certificate of incorporation should be
issued. A private company may begin trading activities from the
date of issue of this certificate.
If formation agents have been involved, they will normally provide
copies of the relevant documents, together with suggested minutes
for the directors' meeting, a form 225 (Northern Ireland form 233)
- change of accounting reference date, and forms 88(2) (Northern
Ireland form 98(2)). They usually also supply the Statutory Book
- a combined register, and minute book (in loose leaf or bound form),
and some blank share certificates.
Post incorporation matters
First meeting of directors
Once you receive the Certificate of Incorporation, you should hold
a first meeting of directors to deal with the following matters:
First general meeting
A first general meeting of the company will be required:
Returns
After the first board and general meetings, you should make the
following returns to the Registrar of Companies:
In special circumstances you might have to make the following
returns:
Other matters
The Law and Directors´ Responsibilities
Who is a director?
A person can be a director without bearing the title. Thus, a shadow
director is defined as ´a person in accordance with whose
directions or instructions the directors of the company are accustomed
to act´. In the case of many companies limited by guarantee,
the directors may be known as ´council members´ or ´governors´.
The Companies Act makes no distinction between executive and non-executive
directors. Non-executive directors are directors for all purposes
of the legislation, and bear all the relevant responsibilities.
Private companies need only one director, but in practice most
have at least two. Companies must maintain a register of directors
and notify the Registrar of Companies of any changes within 14 days.
The relevant forms are:
Common law duties
Since the Companies Act does not provide a comprehensive statement
of directors’ general duties and responsibilities, these have developed
by way of comparison with other legal relationships, as follows:
Fiduciary duty
Each director must act in accordance with what he or she believes
to be the best interests of the company. Directors must not place
themselves in a position in which there is a conflict between their
duties to the company and their personal interests. For example,
in a take-over bid, the fact that the directors as individuals might
hold between them a majority of the voting shares does not mean
they can follow their own individual wishes.
Care and skill
The standard of care expected is, ´such care as an ordinary
man might be expected to take on his own behalf´. The degree
of skill expected is ´such a degree of skill as may reasonably
be expected from a person with (the particular director´s)
knowledge and experience´.
Ratification
In certain circumstances, it is possible for the shareholders to
ratify a transaction that would otherwise be in breach of duty.
Statutory duties
There are numerous statutory duties that apply to directors, many
linked to defaults by the company. If a private company offers shares
to the public, the company ´and any officer of the company
in default´ are guilty.
However there are some duties, whose breach is a criminal offence,
that apply only to directors. One of the most important is the duty
not to deal in securities when in possession of unpublished price
sensitive information (´insider dealing´).
Some legislative provisions impose civil liability upon a director.
For example, a director who signs a cheque that does not have the
company’s ´name mentioned in legible characters´ is
personally liable on the cheque.
Accounts and dealing
Directors´ duties in respect of accounts are stringent and
comprehensive. Directors are responsible for preparing a profit
and loss account and a balance sheet, ensuring that proper accounting
records are kept, and taking all possible steps to ensure that the
accounts show a true and fair view. This is now reflected in the
‘Statement of Directors’ Responsibilities’, which has to be attached
to the statutory financial statements.
Directors are also under a statutory duty to supply auditors with
necessary information and explanations. This is the reason for requesting
´letters of representation´. Criminal liability can
follow if directors ´knowingly or recklessly´ make a
´misleading, false or deceptive statement´ to the auditors.
Duties to whom?
The duties of directors under the general law are owed to the company
and not to its shareholders, so it is the company, or its liquidator,
that can sue. Creditors can, in the case of a company in liquidation,
apply to the court for an order compelling the directors to repay
such sum as the court considers just in respect of the directors´
´misfeasance or breach of trust.´
A director who is knowingly a party to fraudulent trading may also
be personally liable to creditors.
However, although directors have a statutory duty to have regard
to the interests of employees, it is doubtful whether employees
could sue the directors personally, because the director´s
duty is to the company.
Wrongful trading
Wrongful trading may be broadly defined as a failure by a director
or shadow director of a company to take every step that he or she
should have taken to minimise loss to creditors once he or she knew
or ought to have known that the company was unlikely to avoid insolvent
liquidation. The possible penalties for wrongful trading are:
When a company goes into insolvent liquidation, it is necessary
to make a judgement:
Tests of insolvency
There are a number of ways to test for insolvency. You should consider
the following:
Fraudulent trading
Honest directors should not find themselves guilty of fraudulent
trading. Nevertheless, if a company has already incurred liabilities
that it failed to pay when they fell due or shortly thereafter,
the board should consider the position carefully and place on record
the factors that led them to conclude that any further liabilities
incurred would be paid at the proper time before allowing the company
to obtain any additional credit.
Disqualification
Grounds
A disqualification order may be made against a director on the
grounds of:
A disqualification order may also be made if someone is found
guilty of an indictable offence in relation to a company, or is
in persistent default of filing requirements under the Companies
Act 1985. The Companies Act includes some sixty-nine indictable
offences, and there are about fifty separate duties placed on directors
with regard to filing, so there is great scope for a director to
be guilty of either an indictable offence or persistent default!
Duration and effect
A disqualification order will run for a minimum of two and a maximum
of fifteen years.
A person who is subject to a disqualification order may not:
Recommendations
We recommend that, as a matter of good practice, every board of
directors:
Those who are not directors of a company but nevertheless have
a close business connection with it should satisfy themselves that
their relations with the company do not make them shadow directors.
Life is becoming tough for directors. It is difficult enough for
them to discharge all their duties satisfactorily when the requirements
are clear, but unfortunately they rarely are.
Statutory Records
It is essential that you keep your company's statutory records
up-to-date. Do not underestimate the importance of these records
- they are definitive proof of the company's legal existence and
its members, and include:
A company's accounts and annual return must be filed annually
with the Registrar of Companies. Non-compliance will render the
company liable to dissolution with liabilities subsequent to the
dissolution being the responsibility of the directors.
Penalties
The Companies Act 1985 provides for the Registrar of Companies to
charge penalties and fines:
How we can help
As part of our service to client companies, we undertake on receipt
of written instructions to keep the company's statutory records
up-to-date and forward the annual return and accounts to the company
for approval before submitting them to the Registrar of Companies.
Companies - Getting the Timing Right
The timing of certain payments and receipts of income is crucial
for tax purposes. By moving a date of payment or receipt by just
a few days either side of the company’s year end, you can reduce
the tax bill and defer payment until the next tax year.
DO
DON’T
How to Gain the Most out of your Accounting
Records
How to reduce the time taken in accounts preparation
Are your records accurate and reliable?
Ensure that:
Do your records give you adequate information for taking management
decisions?
You should know:
Could your accounting systems be improved?
Company Bonus or Dividend?
In many small companies, the owners are also the directors, and
this gives considerable scope for deciding how profits should be
taken out of the company.
Traditionally, small companies pay salaries to the directors and
tend to ignore their second role as shareholders, which entitles
them to receive dividends.
Where profits are retained within a company, the situation is governed
by the corporation tax rules, but when you draw profit out, income
tax rules take over, and national insurance rears its ugly head.
The main considerations for choosing between salary and dividends
are:
Corporation Tax
This is charged on the profits of the business after taking into
account all salaries. Paying a salary reduces profits and hence
reduces the corporation tax bill.
Income Tax
As mentioned above, income tax is chargeable on all profits withdrawn
from a company. On salary, it is collected through the PAYE system.
A dividend carries with it a 10% tax credit, and for a basic rate
taxpayer there is no further tax to be paid. A higher rate taxpayer
will have to pay additional income tax equal to 22.5% of the gross
dividend.
National Insurance Contributions
National insurance contributions are payable on salaries, but not
on dividends. There are two elements - employee contributions and
employer contributions. Employees pay 11% on earnings between the
earnings threshold and the upper earnings limit, and 1% on earnings
above this without any upper limit. Employers pay 12.8% on all salaries
above £5,035 p.a. without any upper limit.
Company law
Salaries can be paid even when a company is making a loss. Dividends
can be paid only out of profits for the year, or any undistributed
profits from previous years.
Other shareholders
Salaries can be allocated to different directors at any rate. A
shareholder is entitled to a dividend in proportion to the number
of shares held. This means that non-working shareholders would participate
in any dividend declared.
This lack of flexibility can be countered by creating different
classes of share with different dividend entitlements.
Cashflow
PAYE and national insurance are payable monthly; corporation tax
is payable nine months and one day after the company's year end.
Additional income tax on dividends is payable on 31 January after
the end of the tax year in which the dividend is paid (payments
on account may be required).
Pensions
Payments of additional salaries can enhance the contributions that
can be paid to pension schemes. For certain types of scheme, benefits
can be based on the pay for the best three out of the last ten years
before retirement, so planning for high salaries can be used to
advantage.
Interest and Tax Payments
HM Revenue & Customs charges interest on underpayments of
tax, and pays interest (repayment supplement) on overpayments. The
rate of interest paid on overpaid tax is lower than the rate charged
on underpayments, and interest rates are adjusted frequently in
line with commercial interest rates.
Detailed calculation of interest and supplement are not shown on
Statements of Account, so it is worth checking when these items
are large.
Income Tax and Capital Gains Tax - self assessment
Interest is charged on underpaid payments on account and balancing
payments from the due date to the date of payment. Repayment supplement
is paid from the date of overpayment to the date the repayment is
issued. The interest or supplement is based on the final amount
of tax and Class 4 national insurance contributions, taking into
account all later adjustments.
Interest is also payable on late-paid penalties and surcharges
(but not on interest!).
For individual taxpayers interest charged by the Revenue is not
tax-deductible, but neither is interest paid by the Revenue taxable
income.
Corporation Tax - self assessment
Similar principles apply with regard to corporation tax. However,
interest rates are not necessarily the same as those applying to
income tax and capital gains tax. In addition, there are different
rates of interest for companies required to make quarterly payments
of corporation tax.
In contrast to the position with personal taxpayers, under corporation
tax self assessment interest charged is allowed against company
profits and interest received is treated as taxable income.
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