For many small businesses, trading as sole traders or traditional partnerships, a key consideration is if, and when, they should transfer the business into a limited company, known as an incorporation. 

Incorporating a business is a significant and complex decision that requires detailed analysis, and the position will be unique to each business. Furthermore, tax is only one aspect that should be considered, along with various other legal, commercial and practical implications. 

In addition, with the recent changes introduced in the 2024 UK budget, the ‘goal posts’ may have moved and hence the benefits and drawbacks of incorporation should be reassessed to determine whether it remains a worthwhile option. 

Advantages of incorporation

Broadly, the benefits of incorporation can be summarised as follows: 

• Limited liability – shareholders of a company cannot normally be held liable for the actions or debts of a company, though this is sometimes eroded by third parties, such as banks, who can require personal guarantees from the directors/shareholders in respect of the company’s borrowings. Limited liability can also be lost when the directors continue to trade when the company is insolvent.  

• Credibility and trust – a company can convey professionalism, stability, and longevity, which can be advantageous when dealing with clients, suppliers or investors.

• Investment opportunities – companies can issue shares, allowing for greater discretion over equity ownership. In addition, the government uses the tax system to incentivise external investment (for example using the Enterprise Investment Scheme), as well as employee participation through share schemes (such as the Enterprise Management Incentives scheme). Additionally, incorporated businesses often find it easier to obtain business loans, credit lines, and other forms of financing from banks and financial institutions. However, it is important to note that newly incorporated businesses will not have any credit history, which can cause issues early on in a company’s life in terms of raising finance.

• Tax benefits and incentives – incorporation can provide tax advantages, such as lower rates of tax on profits and additional tax-allowable deductions. The Government also offers certain tax incentives and schemes exclusively to companies such as Research & Development tax relief and ‘full expensing’ of certain capital expenditure. 

Disadvantages of incorporation

There are, however, some drawbacks of an incorporation, typically around compliance. A company and its owners must comply with various legal and regulatory requirements, over and above what is required for an unincorporated business. These include maintaining additional financial records, filing publicly available annual accounts (unless already trading through a Limited Liability Partnership), submitting Corporation Tax returns, and adhering to company law. In addition, for larger businesses, there may be a requirement for an audit of the financial statements. 

One other point to note is that the equity ownership of companies is more rigid than a partnership, for example. This can in some cases mean that succession and changes in business ownership can be more complex when the business is operated through a company. 

Tax implications of an incorporation

There are two aspects of an incorporation from a tax perspective: the implications of transferring the business to the company, and then the ongoing tax landscape post-incorporation.  

On incorporation, the business owners will need to consider the implications based on the assets held in the business. Capital assets (such as land and buildings) assets attracting capital allowances (such as plant and machinery, or fixtures), goodwill and other intangible fixed assets, stock and cash will all have their own tax implications and considerations. In addition, the position will depend on whether there are any tax losses available to the owners, and whether the business is VAT registered. 

Once incorporated, the now director/shareholders will remunerate themselves out of the company profits. Extracting profits from companies again is an area where there are lots of variables and careful planning is required. For example, profits can be extracted by way of salary, dividends, rent, interest charges or pension contributions, all of which have different tax implications. 

Tax implications post-2024 budget

The 2024 budget introduced several changes that could impact the tax implications of an incorporation, including: 

• Corporation Tax – the Government has committed to capping the main rate of tax at 25% for the duration of this Parliament, whilst the small profits rate is maintained at 19%. In addition, they have confirmed that the current generous capital allowances regime will remain. Whilst the rates of tax are attractive compared to Income Tax on unincorporated profits, the tax implications of extracting profits from a company must also be considered.  

• Employer’s National Insurance Contributions (NICs) – from April 2025, the rate of employer’s NICs will increase from 13.8% to 15%, and the threshold at which employers start paying NICs will be reduced from £9,100 to £5,000 per year. An owner/manager of a company taking a small salary has historically been advantageous from a tax perspective, and thus weighing up the increased tax costs versus other benefits such as accruing entitlement to state pension must be considered. 

• Capital Gains Tax (CGT) – the rates of CGT have increased from 10% to 18% for the lower rate and from 20% to 24% for the higher rate. This change may affect business owners considering transferring property or goodwill into a company as part of an incorporation, or where a sale of shares in the recipient company may take place within two years of the incorporation – meaning no Business Asset Disposal Relief would be available (see below). 

• Business Asset Disposal Relief (BADR) – the rate of CGT under BADR will remain at 10% for now but will increase to 14% for disposals made on or after April 6th 2025, and to 18% for disposals made on or after April 6th 2026. This change may affect business owners considering transferring commercial property as part of an incorporation. 

Is incorporation still worthwhile?

Given the changes in the 2024 budget, the decision to incorporate a business should be carefully evaluated. As mentioned above, each case will be different and thus it is not possible to give an absolute answer. Instead, the following should be considered in detail, including modelling any tax or cost implications, to determine whether incorporation is the right answer for your business. 

• Risk management – the limited liability protection offered by incorporation remains a significant advantage, especially for businesses with higher risk profiles. Protecting personal assets can provide peace of mind and financial security. 

• Tax planning – whilst the increase in employer’s NICs and CGT rates may reduce some tax benefits, a company still offers some tax advantages over unincorporated businesses. 

• Growth and investment – incorporation can facilitate access to investment opportunities and financing, which can be crucial for business growth. The ability to issue shares and attract investors can provide the necessary capital for expansion. It also enables ownership to be passed to future generations, which is a valuable succession planning tool. 

• Administrative burden – the increased administrative responsibilities and costs associated with incorporation should not be overlooked.