Incorporate in haste and err at leisure

Adam Bernstein
Wednesday, October 26, 2022

Company tax law can trip up many a business and its owners, especially when the rules around owning and running a company are not properly understood.

Selecting the appropriate business structure is an important decision and it is not uncommon for a business to start as either a sole trader, owned and operated by one person, or a partnership where there are two or more people, before incorporating into a company via the creation of a new legal entity to which an existing business can be transferred. 

So, to understand where owners go wrong and where they make expensive mistakes, Printweek sought the advice of two accountants for their top five causes for concern.

Helen Thornley, technical officer at the Association of Taxation Technicians

A separate entity

Helen Thornley begins by tackling the misuse of company assets and makes the point that in being a separate legal entity, a company needs its own bank account and the funds in that account will belong to the company. She says that “a company is owned by the shareholders and run by directors, although in a small business these are often the same people”. Even so, she reminds that “the assets of a company belong to the company, and director-shareholders can’t use the company account as their personal piggy bank, even if they own 100% of the shares.”

So, if directors want access to cash held by the company, then they will need to pay themselves a salary or vote dividends, both of which will have personal tax consequences for the individual.

Transfer of assets 

The second cause for concern for Thornley is that of asset transfer. Here she talks about the decisions that must be taken on incorporation regarding assets of an existing business that are to be transferred to the new company. She warns that “the transfer of assets such as property, plant and machinery can all have tax consequences. There are reliefs and elections available to mitigate the tax costs of incorporation, but certain conditions will need to be met.”

Thornley says that “particular care needs to be taken with assets which are used both in the business and personally, and also with land and property” and gives an example: a director’s car. She explains that “if a director transfers their vehicle to the company as part of the incorporation or gets the company to buy a car which they can use privately, then a benefit in kind will arise which is taxable on them. This is why it is often simpler and more cost-effective for a director to keep their car and recover business mileage at the approved mileage rates, although this does require them to keep records of their business mileage”.

And then there’s the question of whether or not to transfer property such as trading premises into the company which Thornley says “is also a big decision with a lot of competing factors to consider”.

If the decision is taken to transfer in, then Thornley says that there will be upfront costs including fees for transferring any mortgage to the company, and taxes such as Stamp Duty Land Tax (or LBTT/LTT in Scotland and Wales) and Capital Gains Tax. She adds – and cautions – that “the property will also form part of the company’s assets in the event of a claim against the company. But if the property is kept out of the company – which may allow for the charging of rent and help to protect it from claims against the company as well as being simpler – that could reduce the availability of Business Property Relief (BPR) in the future and claims for tax reliefs on future sales could be affected”. BPR is a very valuable relief which can exempt up to 100% of the value of qualifying assets from inheritance tax.

Overdrawn directors’ loan account

The third mantrap awaiting directors outlined by Thornley follows from failing to keep company and personal expenditure separate as it can lead to an overdrawn director’s loan account. “If this is not spotted early there will be interest and penalties to pay,” Thornley comments.

In overview, if a director has put money or assets into the company then the company owes the director and it can, when there are funds available, repay them. The problem arises, as Thornley tells, where a director draws more money out of the company than the company owes them, which is effectively treated as a loan to the director: “If this loan is not repaid within nine months of the company’s year-end, the company must pay what is effectively a penalty charge of 32.5% of the amount overdrawn at the year-end to HMRC.”

The net effect is that either the director will need to transfer money (or assets) back to the company or vote themselves more dividends or salary – which will have a personal tax consequence – to give them the funds to repay the loan. 

And if a director is overdrawn by more than £10,000 at any time during the year, they must also pay interest to the company at a minimum rate set by HMRC or be assessed to be in receipt of a benefit in kind.

Informing customers and suppliers

Another area where Thornley sees directors make mistakes is in the failure to inform customers and suppliers of the business that it has incorporated and that they are now dealing with a different legal entity. As a result she advises that “all websites, email signatures, letterheads, stationery, invoices, order book, etc all need to be updated to show the company’s name, where it was registered (England & Wales, Northern Ireland, Scotland or Wales), the registered number, and the address of the registered office”.

Very simply, a company that does not disclose all the details required risks fines for both the company and the directors.

Statutory duties

The last of Thornley’s five key trouble spots revolves around company directors not fulfilling their legally set responsibilities to the company. She says that these include acting to promote the success of the business, exercising reasonable skill and care, as well as avoiding or managing conflicts of interest between what is for the benefit of the company and what would benefit the director personally: “Failure to do this can result in serious legal consequences for the director who might be held liable personally for any failures to uphold their duties.”

Kieron Batham-Tomkins, senior tax manager at accountancy firm, BHP

Payroll and paperwork

Few gravitate to payroll and paperwork which is why Kieron Batham-Tomkins sees many clients who don’t understand that on top of Companies House and HMRC filing requirements in relation to the running of a limited company, “many don’t comprehend the detail and obligations of running a payroll and the need to complete paperwork such as dividend vouchers”.

“Directors,” as Batham-Tomkins points out, “with a limited company as the working entity, will be extracting profits via salary and dividends, and in order to pay salary, some form of payroll system will be required which allows Real Time Information (RTI) to be sent to HMRC and provides a payslip each month, along with a P60.” To make this easy and to reduce the chance of errors, he recommends a payroll system which will also allow firms to collect tax on benefits via PAYE codes.

He adds that “when declaring dividends, it is also important to make sure that paperwork is completed with regards to board minutes and dividend vouchers”. Of course, in practice, most owner mangers are sat at home, around a dining room table, when dividends are ‘declared’. Regardless, he reminds that “the paperwork still needs to be on file to show that a decision was made on a set date to declare dividends and extract remuneration”. Not having this paperwork in place could lead to questions from HMRC.

Not checking tax rates

Another problem area for Batham-Tomkins is the lack of tax planning in the way in which directors pay themselves.

He knows that as a rule of thumb, the most tax-efficient way of extracting profits from a company is via an NI-level salary and the remainder being extracted as dividends. By ‘NI-level salary’ he’s referring to a level of salary where no employee National Insurance arises, but where the individual will still receive a stamp towards their state pension.

Batham-Tomkins explains that with an NI-level salary “the company will also receive a corporation tax deduction for the salary paid, unlike dividends which come out of post-tax profits – a potential saving.”

For the 2022/23 tax year, an NI-level salary of £11,908 is normally recommended for directors.

But there are other considerations beyond a NI-level salary for those extracting monies from a limited company says Batham-Tomkins.

Firstly he asks if the company is undertaking and therefore claiming research & development tax credits? If so, he says “it might ultimately be more tax efficient to pay more salary, as salary receives an enhanced deduction, whereas dividends do not”.

Something else to note is the relevance of the state pension age. Here Batham-Tomkins says that “if an individual is over state pension age and therefore at a point where no employee national insurance is due, then they should run calculations as to whether salary becomes more efficient than dividends.”

Lastly, Batham-Tomkins advocates keeping an eye on ever changing tax rates. Specifically, he says that “as rates of tax change for both income tax, national insurance and corporation tax, it is always worth taking advice or running calculations to check that the rule of thumb is still most tax efficient”.

Trivial benefits add up

Another mistake that Batham-Tomkins sees directors – and their companies – often make is the failure to make full use of the trivial benefits exemption. Over the course of a year he says that “these can add up and serve as a nice little ‘extra’”.

Effectively, under the trivial benefits rules, a director can receive six lots of £50 gifts from their company each year, with no tax implications.

But there are rules to observe and Batham-Tomkins details that “the gift cannot be cash or a cash vouchers, and it also can’t be a reward for service or performance, but as long as there are six reasons throughout the year such as a birthday, Easter, Christmas, an anniversary or the like, then the company can provide a director with up to six gifts throughout the year – completely tax free.”

What happens at the end?

It’s all well and good running a business, and doing so successfully, but part of the story is considering what will happen at the end. In other words, how will the owner – directors - bring the business to a conclusion – an exit?

Batham-Tomkins says that as a sole trader, it can be relatively straightforward to end the business as “all income was taxed as it was earned, leaving the individual to just ‘walk away’ from it knowing what they have earned is theirs”.

But the situation is very much different for a limited company. Here he says that “thought needs to be given on how the company may be wound up”. He asks: “Can the company be sold? Is it going to be passed down to the next generation? Has the company come to an end and if so, how are funds going to be extracted – by dividend or through a liquidation?”

From his perspective, too few company owners think about the end game in good time and so either lose value, pay too much tax on the exit or both. As he says, “all of the possible scenarios need good planning well in advance to understand the tax implications and what the best option is for the company and the individuals involved.”

The right advisors

Batham-Tomkins moves to his final point: making sure that company owners have the right advisors in place to offer the most up to date and bespoke advice for them and their business.

He recognises that he is naturally biased, but nevertheless he says that “having the right advisors at the right time can help save tax upfront, down the line, and help avoid any pitfalls that come with running a company”. As he says, “in the fast-paced world in which we live, what can be sound advice today, might not hold true in six- or 12-months’ time”.

In summary

It’s very easy for a business owner to misunderstand the law in relation to companies. It’s also true that owners can miss out on perfectly legal tax-saving steps that they can take. Good advice is, simply, essential. 

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