Hazards and pitfalls of incorporation

Consider a March 2022 case concerning a care home. Having run as a partnership for some 14 years, in 2009, the ownerfollowed their accountant’s advice to incorporate as La Luz Residential Home Ltd.

However, it does not appear the owners familiarised themselves with the implications of incorporating and their duties on becoming directors. In fact, despite the change in its legal status, the home carried on largely as before, with transactions continuing through the partnership bank account, and the businesses suppliers and customers unaware of the company.

Compounded by other tax issues, this approach resulted in substantial tax liabilities and penalties, potentially running to six figures.

Separate entity 

Being a separate legal entity, the company needs its own bank account and the funds in that account belong to the company. A company is owned by the shareholders and run by directors although in a small business these are often the same people; the assets of a company belong to the company, and the director-shareholder can’t use the company account as their personal piggy bank, even if they own 100 per cent of the shares. If they want access to cash held by the company, they will need to pay themselves a salary or vote dividends, both of which will have tax consequences for the individual. Transfer of assets

On incorporation, a decision must be taken regarding what assets of any existing business are to be transferred to the new company. The transfer of assets such as property, plant and machinery can all have tax consequences, although reliefs are available. 

Particular care needs to be taken with assets that are used both in the business and personally. Consider a director’s car. 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. It is often simpler and more cost effective for a director to keep their car and recover business mileage at the approved rates.

Whether or not to transfer property such as trading premises into the company is also a big decision with a lot of competing factors to consider. This involves 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. The property will also form part of the company’s assets in the event of a claim against the company.

Keeping the property out of the company could reduce the availability of business property relief in the future and claims for tax reliefs on future sales could be affected.

Overdrawn directors’ loan account 

If the director has put money or assets into the company then the company owes the director and it can, when there are funds available, repay the director.

The problem arises 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 per cent of the amount overdrawn at the year end to HMRC. Either the director will need to transfer money (or assets) back to the company or vote themselves more dividends or salary to give them the funds to repay the loan. If the 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 a benefit in kind. 

Informing customers and suppliers

Legally, customers and suppliers must be informed they are now dealing with a different legal entity. To avoid the risk of fines, websites, email signatures, letterheads, stationery, invoices and order books must be updated to show the company’s name, where in the UK it was registered, the registered number and the address of the registered office.

Statutory duties 

Directors must fulfil, by law, certain responsibilities to the company. These include acting to promote the success of the business and avoiding or managing conflicts of interest between what is for the benefit of the company and what would benefit the director personally. Companies House and company accounts

Company accounts are more formal than partnership accounts and need to be prepared in accordance with specific reporting standards and filed with Companies House, where they are then made publicly available. 

Although the amount of accounting information provided is not great, particularly for small companies, there will be some loss of privacy, and personal details about the directors and controlling shareholders will also be publicly available. Directors need to ensure details held by Companies House are kept up to date. Other filings required by law include the annual confirmation statement.

In addition to preparing the company accounts, the company will need its own corporation tax return. Directors will likely need to complete and file personal tax returns via self assessment to report salary, interest or dividends paid by the company.

In summary, it’s easy for business owners to misunderstand the law. Good advice is essential. 

Helen Thornley is a technical officer at the Association of Taxation Technicians