The key attractions of starting a business in an unincorporated form are flexible loss relief and administrative ease. In particular it may be desirable to start up as a sole trader to test the viability of a business idea, as the cost of starting up is low and it is easier to wind up the business if it fails to take off. Relief for opening years’ losses are also significantly more favourable for sole traders.
However, once a business starts to sustain more significant profits it is usually advisable to incorporate in order to benefit from favourable tax rates on retained profits. On a simple comparison, the difference on tax rates for retained profits between companies and unincorporated businesses may be up to 28% (ie 19% main rate of corporation tax versus 47% higher rate of income tax and Class 4 NICs combined). This difference is only set to increase as the main rate of corporation tax is to reduce to 17% by 2020.
For more information on determining the tax benefits associated with unincorporated businesses, see the Incorporation for sole traders guidance note and Fillable proforma – incorporation calculator.
The main tax issues to consider on incorporation are capital gains tax and, where valuable land and buildings are transferred, Stamp Duty Land Tax. There may also be significant VAT issues involved.
Effective planning must consider the most appropriate options in each scenario, taking into account the business’ assets and the owner’s future intentions. Advising on incorporation should be undertaken by a suitable experienced tax professional, and advice from a valuation specialist may also be required.
This guidance note gives a broad overview of the tax issues involved and links to more detailed guidance on each subject.
For an aide memoire of the tax implications of incorporation based on this guidance note, see the Checklist – tax implications on incorporation.