Thinking about moving your business into a limited company?
Incorporation can offer tax advantages, legal protection and a more professional image, but it also comes with upfront costs, administrative changes and potential tax traps.
Below, we look at the key points to consider before making the switch.
What does incorporation mean?
The term incorporation usually refers to transferring a business into a limited company. It can also include moving from a traditional partnership to a limited liability partnership (LLP).
Like limited companies, LLPs are separate legal entities. However, for tax purposes they are treated just like ordinary partnerships. That means profits are taxed directly on the individual partners (known as ‘members’ in an LLP), not the LLP itself.
So, turning a partnership into an LLP is generally not a taxable event, but becoming a limited company is.
Capital gains tax
When a sole trader or partnership transfers their business into a limited company, HMRC treats it as a disposal for Capital Gains Tax (CGT) purposes. Even though the same person now owns the company, the transfer is still seen as if the business has been sold.
For example, imagine a sole trader running a plumbing business with equipment worth £40,000 and goodwill (the extra value of a business through i.e. reputation, brand and loyal customers) valued at £60,000. When they transfer these assets into a new limited company, HMRC treats this as if they have sold the business to the company for £100,000. That creates a potential capital gain.
If all business assets are transferred, any gain can be rolled into the value of the shares received in exchange and therefore not payable immediately. This automatic relief is known as incorporation relief (under TCGA 1992, s.162).
However, it is important to seek advice as the relief may not be available depending on the circumstances.
To qualify for relief, all assets (except cash) must be transferred into the company. If they are not, the relief is not available and CGT becomes payable.
If incorporation relief is not available, the business owner may receive consideration in the form of a director’s loan account. This balance can then be drawn down tax-free, as long as the company has sufficient funds.
To put this simply: if you “sell” your business to your own company for £100,000, that £100,000 appears as a director’s loan you can later withdraw. If you overvalue the business, however, and draw down more than the true value, the excess can be taxed as a dividend. So it is important to get a proper valuation before transferring.
Stamp Duty Land Tax (SDLT)
Another key issue is stamp duty land tax (SDLT) in England and Northern Ireland, and the equivalent devolved taxes in Scotland and Wales.
When land or buildings are transferred to a company that you control, HMRC usually charges SDLT on the market value of the property, even though no money changes hands. This can be a major cost, and the SDLT must be paid within 14 days of completion.
In some family partnerships, where all partners become the company shareholders, it may be possible to claim relief under FA 2003, Schedule 15. However, there are strict anti-avoidance rules. For example, if the property leaves the company within three years, SDLT may become payable after all. Other provisions (such as FA 2003, s.75A) also allow HMRC to challenge any arrangements designed to avoid SDLT.
A genuine business incorporation for commercial reasons is unlikely to be challenged, but this is a complex area and professional advice is essential.
Ongoing tax differences
Once a business is incorporated, its profits are subject to Corporation Tax rather thanIncome Tax. The business owner is then taxed separately on any money they take out, usually through salary and/or dividends.
This separation means the overall tax burden can be lower, especially when profits are retained in the company or withdrawn strategically. However, poor planning can lead to unexpected tax bills, so it is worth reviewing your extraction strategy regularly.
Pensions and profit extraction
Incorporation gives you more flexibility over how and when you take income. For example, the company can make pension contributions directly on your behalf, which may be tax-deductible for the business. You can also plan the timing of dividend payments to smooth out your personal tax liabilities from year to year.
VAT and administration
Do not overlook the practical side of incorporation. You will need a new VAT registration number, PAYE scheme and business bank account. You will also be responsible for new statutory filing obligations, including annual accounts, Corporation Tax Returns and Confirmation Statements to Companies House.
For some smaller businesses, these additional requirements can increase administrative costs, so it is worth factoring this into your decision.
Losses and timing
Losses carried forward in an unincorporated business cannot be transferred into the company. If you currently have trading losses that could be used against future profits, it may be better to wait until they have been fully relieved before incorporating.
Timing the move correctly can make a real difference to your overall tax position.
Profit levels and personal circumstances
Incorporation is not always the right move. If profits are modest, the ongoing costs of company administration and higher accountancy fees might outweigh the potential tax savings.
Equally, your personal circumstances matter. For example, those drawing most of their income each year may find the benefit of lower Corporation Tax reduced by the additional dividend tax.
Future sale or exit
If you plan to sell your business later, incorporation changes how any sale will be taxed. Selling shares in a company can qualify for Business Asset Disposal Relief, giving access to a lower rate of CGT, but there can also be double taxation if the company sells its assets rather than the shares.
Understanding your long-term goals will help structure the company in a way that supports your exit strategy.
Practical tip
When weighing up incorporation, do not just focus on the future tax savings. Consider the upfront costs too, particularly any CGT or SDLT due on transfer. Even if there is a one-off tax cost at the start, the long-term benefits of operating through a company may still make incorporation the right choice.
Talk to SeavorChartered
Every business is different. The right structure depends on your profit levels, personal goals and long-term plans. Our team can help you model the short and long-term tax effects of incorporation, guide you through the process and ensure it is done efficiently.
Contact us to discuss whether incorporation is the right step for your business.
