Reproduced with kind permission from Nursery Management Today March/April issue 2013
To incorporate or not to incorporate? That is the question, says Carol Cheesman, who talks readers through some of the issues you have to consider before taking – or not – the big step.
You have a fledging nursery business or perhaps you’re planning to open one. You are excited about setting it up, going out to tell everyone and starting to make your fortune. But are you going to take the time to consider how you should set it up, what vehicle you should use to operate through?
My guess is that it either doesn’t cross your mind or if it does, only fleetingly. You will probably think, “Why should I pay a solicitor to advise on the structure?” After all, you don’t have much money, and all that you have you want to invest in the new business – premises, advertising, finding the right staff and so on. Sounds familiar?
Yes, but planning – as with everything that you do in life – is key. At best, planning reaps great rewards in the future. At worst, it can save you the cost of having to pay to sort out problems further down the track.
When you set up in business you could be a company, a partnership, a limited liability partnership or a sole trader, to name but a few. So, how do you decide? One of the first things to think about is, perhaps surprisingly, not tax but risk.
Is what you are planning to do financially risky? For instance, if you rent premises for a fixed period and it doesn’t work out, you’ll be left with a lease. If you buy plant and equipment like climbing frames and toys or perhaps a minibus under hire purchase, that minibus too will become your liability. And so will any over-stock, (possibly supplies that are charged out to parents): it will sit on your hands until you either give it away – or pay to have it disposed of.
Or perhaps there is the risk that you could be sued.
If you are a sole trader or a partner in an unlimited partnership, any of the above could become personal liabilities. This means that the claimant, be it the landlord, hire purchase company or client, would have access to all your personal assets – including your house. In these situations, you may well be best advised to trade through a limited company or limited liability partnership, whatever the size of your expected profits.
Incorporate or not?
If there is no significant financial risk – or at least you are not concerned about it – the next thing to consider is the anticipated level of profit and the amount of income that you are going to need to live on. As a rule of thumb, if your profits are likely to be £50,000 or less, it is unlikely to be cost-effective to incorporate from a tax point of view. Similarly, if your profits are likely to be £500,000 and you need £500,000 to live on (in other words, you need to draw out the full £500,000 from the company in order to live), then again it is unlikely to be cost-effective to incorporate from a tax point of view.
The reason for this is that small companies only pay tax on their profits at a rate of 20 per cent, whereas an individual currently pays tax at 22 per cent, 40 per cent and 50 per cent (reducing to 45 per cent from 6 April 2013) depending on the level of income/profitability.
As an example, ignoring National Insurance, if you are a sole trader with taxable profits of £100,000 needing £40,000 to live on, you would pay income tax of approximately £30,000 whether or not you drew out all the money (or indeed were able to as some of it may be tied up in stock, debtors etc.) If you were a company and made the same level of profits, drew £40,000 net salary the total tax bill of you and the company would be approximately £24,000.
However, there is a lot more planning to do than just your perception of the risk, what level of remuneration you require and what level of profits you anticipate. If the risk is containable then it may be beneficial to start to trade as a sole trader or even a partnership to ’build’ a business.
How to incorporate
Once you have several years of trading behind you, then you might consider incorporating either by swapping your ownership in the business for shares in a company or selling your business to a newly formed company. The profit that you make in selling your business into a company would be considered as a capital gain and taxed at either 10 or 18 per cent depending on your personal circumstances – a lot less than 22 per cent, 40 per cent or 50 per cent (reducing to 45 per cent from 6 April 2013).
How is the company going to be able to afford to pay me? I hear you saying. Well, you would have to agree deferred consideration with the company (payment over a period), which, in effect, means that you will be able to draw money out of the company from which your business will now be trading at a significantly lower rate of tax than if you had continued as a sole trader. As you would expect, this is not quite as simple as I have made it sound and needs careful consideration, but if done correctly, can be very advantageous.
What about shares?
Another aspect of incorporation that you should consider is who should own the shares in your company. What about having all the family as shareholders? You could have different classes of shares, different voting rights and so on. You could then pay out excess profits as dividends to particular classes of shares which, if to a lower-rate or non-tax payer, would not attract any further tax and therefore be received in the recipient’s hands effectively taxed at 25 per cent.
Anyone can own shares – even a new-born child, and, although such a strategy needs careful planning, it can prove a very effective way of increasing a family’s disposable income, planning for school fees or expensive weddings, helping with first-time property purchases and so on.
Getting it right
In the limited space available, I hope that I have been able to give you a taste of the financial-planning opportunities that are available when you set up or expand a nursery business. You will be working very hard to make that business a success and will be prepared to spend time generating business and continually improving the quality of your service. But how many people are prepared to spend equivalent time talking to an accountant about how to structure their business in order to make the most out of their hard work? After reading this article, I hope that you will.
Health warning: you must contact an accountant before implementing any of the above changes, as much depends on personal circumstances.