Should You Consider Incorporating Your Business? The Tax Benefits Explained

Introduction

As a business owner, one of the most important decisions you’ll face is how to structure your business. Whether you’re a sole trader, in a partnership, or running a family business, the option to incorporate—by setting up a limited company—can bring significant advantages, particularly when it comes to tax.

But is incorporation right for your business? In this blog, we’ll explore the key tax benefits of incorporation and why now might be the perfect time to make the switch, especially with potential tax changes on the horizon.

What Does Incorporation Mean?

Incorporating your business means turning it into a legal entity separate from yourself, typically a limited company. This structure offers a number of benefits, including limited liability for company debts and the ability to raise funds more easily. But the real draw for many business owners lies in the tax advantages.

Key Tax Benefits of Incorporation

1. Lower Corporation Tax Rates

One of the biggest benefits of running a limited company is the difference in tax rates compared to personal income tax. Companies currently pay Corporation Tax on their profits at a rate of 25% (as of 2023), which is often lower than the personal income tax rates of 40% or 45% for higher and additional rate taxpayers.

By incorporating, you may be able to pay less tax overall, especially if your business is generating significant profits.

2. Dividend Payments vs. Salary

As a company director, you have the flexibility to pay yourself in two ways: a salary or dividends. Dividends, which are profits distributed to shareholders, are taxed at a lower rate than income tax. The dividend tax rates for the 2023/24 tax year are 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers.

This makes it possible to take a modest salary (which reduces your National Insurance Contributions) and the remainder as dividends, reducing your overall tax bill.

3. Carry Forward Losses

Incorporated businesses can carry forward any trading losses to offset against future profits, reducing your tax liability in more profitable years. This can be especially beneficial if your business has fluctuating income, helping smooth out your tax obligations and providing relief when it’s most needed.

4. Tax-Efficient Investments

Running a limited company also opens the door to more tax-efficient investment opportunities. For example, company profits can be used to invest in a pension scheme, and you can claim Corporation Tax relief on these contributions. The company can also benefit from tax relief on other allowable expenses such as research and development (R&D) or employee benefits.

5. Selling Your Business – Entrepreneur’s Relief

If you ever decide to sell your company, you could benefit from Entrepreneur’s Relief (now called Business Asset Disposal Relief), which allows you to pay a reduced Capital Gains Tax rate of 10% on the sale of qualifying business assets. This can significantly lower your tax liability when exiting your business compared to selling an unincorporated business.

Is Incorporation Right for You?

While incorporation offers many benefits, it’s not the right fit for every business. There are additional administrative responsibilities, such as filing annual accounts and company tax returns with Companies House and HMRC, as well as legal duties for directors. However, for businesses with consistent profits or ambitious growth plans, incorporation can be a game-changer when it comes to tax efficiency.

Conclusion: Time to Consider Your Options

As the Budget approaches, potential changes to personal and business taxes could influence your decision to incorporate. If you’re a sole trader or partnership, it’s a good time to review your current structure and see whether forming a limited company would work for you.

To ensure you’re making the most of tax reliefs and preparing for any future changes, consulting with an accountant is a wise move. At CBS Accountants, we provide personalised advice on incorporation and business structuring to help you navigate these critical decisions.