This blog is part of a YouTube video series: https://www.youtube.com/watch?v=fE_9ba1nyqU
So, lately, things have been going great for you as a freelancer or sole trader. Business has been growing, you’re making regular income, finding your niche in the market, building that reputation, and now you feel it’s time to take that next big step towards becoming the boss of your very own company.
Incorporating simply means starting a limited (or Ltd) company and it has tons of advantages over being a sole trader.
You may already know that as a sole trader, you and your business were indistinguishable, which meant you were personally liable for all of its legal problems and liabilities. But as a limited company, your business is now a separate, living, breathing, virtual entity, which means you’re protected from most of that drama that it may face.
But a greater advantage of incorporating your business into a limited company is the tax breaks. As an owner and manager of a limited company, the UK government has given you a huge range of tax incentives that allow you to combine your company and household finances to achieve a variety of tax-saving and wealth-creating strategies. You also benefit from cheaper rates for bank loans and credit, as well as the ability to really see your business grow through outside investment and government-backed schemes. Many schemes such as grants offer you capital and access to resources and markets whilst others schemes such as issuing entrepreneur shares like EIS, SEIS, VCT gives your investors a lot of different tax breaks. And finally, as a limited company you can create special employee schemes to attract and retain the best talents.
But in my experience as an accountant and tax advisor, I’ve come across 6 common mistakes that people make when they incorporate their freelance and sole trade business in the UK. And if you have already incorporated within the last two years and recognise some of these mistakes, don’t worry, there may still be time to amend things.
Let’s dive in.
NUMBER ONE: VALUING YOUR COMPANY
How would you like to earn up to £12,300 from your own company, absolutely tax-free!? Now, this is an opportunity I see so many people miss out on because when they incorporate their own company, they don’t value their business in the right way.
Most people usually start by forming a company through Companies House or via a formation agent by issuing themselves 100 shares for £1 each and then bringing in their assets and liabilities into the company. In this sense, the value of their company is simply their net assets i.e. their total assets minus total liabilities. And that’s it.
But come on, your business is worth more than that!! Let’s be honest, if I was to compete with your business today, it would take me much more than simply buying the same stuff as you to succeed. This is because for you to have become the success that you are, you have had to build value in your business. And that value has “Value”!
Perhaps you achieved amazing customer loyalty, won over hundreds of 5* Google reviews, developed clever new work processes, have access to unique resources, built up a powerful list of influential contacts, won industry awards, or quite simply, perhaps you have amazing brand recognition.
In my line of work, that value is called Goodwill. And goodwill is an intangible asset which sits on your balance sheet adding actual value to your company like patents, copyrights and licenses.
But wait, what happened to that £12,300 I mentioned? Well, under the right conditions and with the proper method, you can extract that goodwill from your company, tax-free, for up to £12,300 if you incorporated before April 2023 and £6000 if you incorporated after that date until April 2024. This is set to fall further to £3000 by April 2025 so it's worth making a decision soon.
There are many ways in which you can value and extract your goodwill and always it’s handy to have a good accountant by your side. That being said, valuing businesses and helping our clients extract wealth is something we, at IJB Strategia, absolutely excel in doing.
NUMBER TWO – TRANSFERRING STOCK
If you’re a business that sells stock to customers, then you really don’t want to miss this point. When you incorporate a company, you are basically bringing an end to your sole trade. By default, when you transfer your stock to the new company it is basically accepted by HMRC that you are selling that inventory, to your new company, at market price.
Now that sucks because although it means you personally have just earned a lot of money from selling your inventory to your new company (for which you may need to pay income tax on), your new company now has products in its inventory that costs the same amount as the price it will charge to its customers. This means that your company won’t make any profits from these sales.
To avoid this, you and the company will have to make an ‘Election’ that would allow you to treat this stock as being transferred at the amount you paid for it from your supplier as a sole trader. This means although you don’t personally make any profits from the transfer, it now means that your company can sell that stock to its customers and make a profit.
There is a deadline for making this election, so make it soon.
NUMBER THREE: REDOING AGREEMENTS
In essence, when you incorporate, your sole trade ceases to exist, and the LTD company becomes a new entity. A lot of business owners forget that this means they would need to reestablish all prior existing contracts and arrangements they had set up as a sole trader.
This means if you have employees, you need to make new employment contracts as they now work for the company. The same goes for business insurance, and for ownership of vans/vehicles, for bank accounts, and suppliers, lenders and even subscribed customers. You’d need to contact them all and let them know that this new company has taken over from the sole trade business.
NUMBER FOUR: LOSSES
It’s never nice to make a loss and most people make the mistake of simply brushing it under the carpet. However, if you made a loss in your final year as a freelancer and sole trader, then there are a number of very interesting things that you can do with those losses.
One option is that you could offset those losses against profits of that trade from previous years or maybe you’re more inclined to offset the losses against your other sole trader income in that year or perhaps, if you really feeling edgy, you could use those losses to offset your capital gains bill.
However, one of the best options is what we call ‘Incorporation Loss Relief’. This relief allows you to carry that loss forward, into your new company, and use it to offset any income you personally make from that company.
So go ahead and treat yourself to a big bonus that year rest assured that you can reduce its income tax against the losses you carried with you (as well as reduce the corporation tax of that new company).
NUMBER FIVE: CAPITAL ALLOWANCES
Nothing frustrates an accountant more than finding out that their clients are not claiming capital allowances in their business. Capital allowances are tax deductions that businesses can claim for certain capital expenditures like when you buy plant & machinery, equipment and even vehicles which are used in the course of your business.
So when a sole trader incorporates their business into a company, the company can continue to claim capital allowances on these assets, as long as they're used for business purposes. But one mistake people make is to purchase such things in the final year of their sole trade. HMRC does not allow you to claim capital allowances in the final year before incorporation.
However, there is a perfectly acceptable work-around which involves changing your accounting dates. Now I won’t go into that in this blog but in essence it allows you to insert a very small accounting period in between your final year as a sole trader and the accounting period for your new company. That’s right folks; accountants are time wizards!
NUMBER SIX: TAX INCENTIVES
A common mistake I see people make time and time again is that when they start a limited company, they continue to earn an income by only giving themselves a salary. Instead, you can use many of the amazing tax incentives that the UK government has given to owner-managed businesses that allow them to combine their household and business finances in order to achieve tax-reducing and wealth-generating strategies.
By Tax Incentives I mean a variety of different allowances, benefits, credits, exemptions, reliefs and deductions that the UK government has given to you, your household and businesses.
You also have a variety of ways to extract wealth from your company. You’ve got dividends, you got director loans, you got Benefits-in-kind, you go charitable donations, you got pensions, interest income and the many allowable expenses that benefit you directly from taking your family out for meals to buying cars and even renting parts of your house and paying some of its utility bills as a home office. The list goes on and on and on.
Basically, running a business means thinking bigger!
Now most of these amazing tax incentives require planning things well in advance so as to meet certain qualifying conditions that will make you and your company eligible for such incentives. So it is best to start planning as soon as possible.
IT MIGHT NOT BE TOO LATE
I stated earlier that if you have already registered your company and recognise making some of these mistakes then there might still be time to fix things. If you have not submitted your new company’s accounts yet then the issue can be resolved quite simply as most of these mistakes can be corrected. However, even if you have submitted those company accounts (and your self-assessments) then all is not necessarily lost. This is dependent on HMRC rules relating to making amendments to your submitted accounts.
HERE TO HELP
Incorporating your sole trade or freelance business can be a game-changer, but it's crucial to do it right. With the complexities of tax laws and legal intricacies, having a seasoned professional by your side can make all the difference. As experienced accountants and tax advisors, we have helped many businesses seamlessly transition to a limited company structure. We understand that each business is unique, and we work closely with you to develop a strategy that aligns with your specific goals and circumstances. From valuation strategies to capital allowances and tax incentives, we ensure you make the most of the opportunities available to you. Don't leave your business transformation to chance. Take advantage of our expertise and let's embark on this amazing journey together.
Schedule your free 30-minute consultation with us today.
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