Disadvantages of incorporation

Disadvantages of incorporation

If you’re a sole trader, you may have heard that you can save tax by running your business through a limited company. This could indeed be the case, but there are some disadvantages of incorporation.

Disadvantages of incorporation

Running a limited company means more paperwork

Sole traders have to file a personal tax return to HMRC each year. However, a limited company has to file:

  • a set of accounts
  • a confirmation statement
  • a Company Tax Return

In addition, each director nearly always has to file a personal tax return to HMRC.

If you are an employee of your company and take a salary, you will also have to register the company as an employer and set up payroll. You will need to report to HMRC in real time whenever the company pays one of its staff. You won’t need to do this as a sole trader unless you recruit employees other than yourself.

All this means that after incorporation you – or your accountant – will have to spend more time preparing and filing paperwork.

As the director of a limited company, you will have legal duties to fulfil

Your legal responsibilities as company director would include safeguarding the company’s assets and making the decision to cease trading if you knew the company couldn’t survive. If you fail in your legal responsibilities as a director, the consequences can be serious: you could be fined or even go to prison.

Trading through a limited company involves potential tax costs

As the director of a limited company, you would no longer be able to draw money out of your business bank account freely. The company could pay you a salary and/or pay dividends on the shares you own. However, these would be taxable after taking into account your personal allowance and dividend allowance.

Another potential tax implication is that when a limited company makes a loss, it can only use that loss against its own profits. Sole traders, on the other hand, may be able to use some of the loss that their business makes to save tax on their other income. For example, if a sole trader is also employed elsewhere, they may be able to use their business losses to reduce the tax they pay on their employment income.

Limited companies have less privacy than sole traders

When you file your company’s accounts and confirmation statement, these documents will be in the public domain, available for anyone to see on sites such as Companies House and DueDil. This means that your company’s figures will be visible to the public, along with its office address (although you could make this your accountant’s office, rather than your own home).

Other things to consider

Sole traders and partnerships have to pay Capital Gains Tax on profits from selling business assets, and there are various tax reliefs available that may enable them to reduce or delay the amount of tax they have to pay. These tax reliefs do not apply to limited companies, which instead have to pay Corporation Tax on profits from selling their assets.

Helping you with the disadvantages of incorporation.

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