What are the downsides of trading using a limited company and how do I overcome these?

After all, there are about six million companies that have been registered in England & Wales alone. Surely six million company promoters can’t all be wrong?
One of the most obvious reasons to carry on your business through a limited company is to be found in the title itself, limited liability. In addition it gives a perception of substance using a well respected business format.

The downsides of limited companies

Now I turn to the disadvantages of limited companies, and you will see, if you run your eye down the remaining paragraphs of this article, that they a formidable list.

Inflexibility

The money in the company is no longer the shareholders/directors to take and spend as they like. Unless the company actually owes the shareholder/director money, taking funds from the company is going to land you in one of a number of alternative tax charges. A company is also inflexible in terms of the initial capital invested.

Information publicly available

If you have a limited company, you’re obliged by law to make all kinds of information about the company and its business public, including your accounts. The company accounts have to include the infamous “related party transactions” note. This is a notorious invitation to the taxman to ask questions and increase his tax take.

National Insurance

On earnings of £100,000 per annum a director/shareholder of a company has a total National Insurance liability in the region of £16,000. A self employed person receiving exactly the same earnings, would have a liability in the region of £3,500.

The “double charge to tax”

This is arguably the nastiest “con” of all in the limited company list. It arises where a limited company disposes of a capital asset at a gain and then wishes to distribute the net of tax proceeds to the shareholders/directors. The shareholder actually ends up with an effective 46% tax rate, as a result of this “double charge to tax”.

Now contrast that with the same asset being sold by someone who has traded as a sole trader or in a partnership will probably pay 10% (on the first £1 million) and 18% on the balance. Which tax rate would you rather suffer: 46% or the 10%/18% on capital gains?

Car running expenses

This is where the disadvantages of running a business through a limited company are really grim. Alternatively, if you own and run your car personally then what you are doing is financing your motoring expenditure out of your post tax income. You have to earn £10,000 and give HMRC £4,000 before you can spend £6,000 a year on car running expenses!

These disadvantages don’t apply to businesses carried on as sole traders or partnerships because there is no benefit in kind regime applying at all. The whole of the motor expenses can be charged against profits, subject to a private use adjustment.

Start-up losses

I talked above about the problem of companies being inflexible. This is very much a feature of the loss relief regime.

For companies, losses can only be used against other income of the company itself in the same period, or carried forward, except for a limited ability to offset trading losses one year back. This contrasts with businesses run as partnerships or sole traders, where the losses are available directly against the individuals’ other income including, in the first four years, by way of carry back and offset against income three years ago. You could claim a tax repayment at 40% of the amount of the loss!

This lack of flexibility is particularly acute in the early years of a business where, of course, losses are most likely to be incurred. An individual carrying on a business either alone or in partnership can get a very useful aid from the government to his start up cash flow by using the early year carry back, against income in years when he may well have been a higher rate income tax payer. If the business is a limited company from day one, nothing can be done with those losses except carry them forward.

Introduction of new blood

This disadvantage comes about where the existing directors/shareholders want to introduce a key person into equity ownership into the business. When the business is in a limited company, this can only be done by issuing him new or selling him shares. The first route gives rise to an onerous tax charge and the second option lacks commerciality unless the employee has just received an inheritance! A good example of the bureaucratic mentality stifling enterprise in this country.

How do you overcome all of the above downsides?

The one thing this article doesn’t do, and can’t do, is answer your own specific question: should I change my structure from a limited company or not? That’s because everyone’s situation is different. Personally, I think that all of the disadvantages of companies can be overcome by transferring to a limited liability partnership with at least one of the partners being a limited company, with further tax advantages arising, but that’s another subject…. 

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