Sole Enterprise with Protected Assets or Limited Company - Which is better for Contractors?

Contractor Accounting is always a challenging task. The question is, are we likely to advise contractors differently now that the government is exploring a third way, a trading vehicle known as a Sole Enterprise with Protected Asset or SEPA?

When someone sets up a business, s/he needs to make a choice about whether to:

Incorporate and trade through a limited company, which comes with limited liability for the individual, increased administration, and a more complicated tax regime for the business. At the same time, this status offers benefits such as pensions planning through the company, ability to employ yourself and others, and to raise finance. In addition, often, limited companies have a better pick at contracts as agencies and corporations tend to prefer to, are often obliged to, work with legal entities.

Or

Operate as a sole trader, which comes with the potential for unlimited personal liability for business debt, less admin, and a less complicated tax regime. At the same time, this status holds no benefits in terms of pensions planning, you cannot employ people formally, and it is virtually impossible to get finance. In addition, some agencies and businesses will be reluctant, some even unable, to deal with you unless you are a limited company.

Why introduce SEPA?

The Office of Tax Simplification (OTS) has come up with this potential new trading vehicle known as a Sole Enterprise with Protected Asset (SEPA) in response to a report commissioned by the government. It found that the main reason for individuals incorporating their business was the protection of limited liability, primarily protecting their primary residence, and tax advantages.

What is a SEPA?

SEPA will allow an individual to continue operating as a sole trader (with simpler tax and regulatory regime) but their primary residence will be protected against claims from the business. Still in discussion is whether an individual’s pension fund should also have protected status under SEPA, but further information about this will be revealed in due course.

What is the difference between SEPA and incorporation?

- SEPA would not have a separate legal identity like a limited company;

- SEPA status will need to be registered (probably online), but there will be a lot less bureaucracy than for incorporation;

- When SEPA-registered, all activities of the trader would be covered by SEPA status, but this status has few advantages other than limited liability protection;

- The SEPA will be taxed as a sole trader and the SEPA identified, i.e. “J.J. Arthur, SEPA”; there are none of the tax advantages under SEPA as with incorporation;

- Critics doubt whether SEPA status would benefit these businesses when seeking loans or finance, whereas Setting up a limited company would probably stand a better chance of getting finance.

Note that as SEPA is a sole trader model it cannot be shared, so partnerships would have to opt for another structure such as a limited liability partnership or a limited company to protect their personal assets.

Which is better for contractors?

Even though SEPA registration does not offer the full benefits of limited liability status, it does protect the individual’s primary residence from claims against the business, and in that respect, it should be welcomed. It will also go some way to stop incorporation for liability protection and tax purposes only.

However, sole traders interested in registering for SEPA in the future should note that the benefit of SEPA protecting the family home will be lost if a creditor (in particular, a bank) requires a loan to the business to be secured against the property.

Will SEPA benefit businesses and the UK economy?

I’m not against SEPA, but do question it’s effectiveness for businesses with serious intent to grow. In terms of running a serious business—in the true sense of having the idea and the commitment, the drive and the self-belief, in terms of growing it, and having the efficient machinery in order to run it—you still cannot beat incorporation. If you incorporate and accept the wider reporting requirements that come with that status, personally, I feel you stand a better chance of business success.

As to the OTS’s belief that the introduction of SEPA will encourage greater entrepreneurism by allowing sole traders to operate without the threat of losing their family home, that does not convince me either. The new FRS105 micro-entity reporting, in fact, has already reduced the bureaucracy of running a limited company. Therefore, I think, the timing of the introduction of SEPA by the OTS is somewhat late, and it makes me wonder why the OTS does not focus more on making limited company compliance less burdensome, rather than introducing a new structure that requires a lot more energy in order to adjust in the market.

On this issue of less burdensome reporting and compliance procedures of sole traders, it is interesting to note that according to the borrowing figures for SMEs in the last quarter of 2016, around £6 billion was borrowed, and yet something like 80‒90 per cent of start-up businesses failed due to poor cash-flow management.

I’ve written about the importance of good financial management elsewhere and it is this that concerns me here as I conclude.

1. I believe that incorporation may demonstrate to the outside world and not least to other business owners, stakeholders, and clients that the business has a greater commitment to good financial management.

2. I believe that a limited company is more likely to work with an accountant to ensure the success of their business.

3. In my view, the introduction of SEPA flags up that the issue of good financial management still needs addressing by all businesses, whether sole traders or contractors.

4. The idea of protected assets under SEPA might well promote entrepreneurialism, but I wonder if it could also entrench, or be seen to entrench a blasé approach to (good) financial management as well? And finally,

5. Businesses with their eye on growth may need to borrow: would that be possible under the SEPA model? Will banks and other lenders become cautious and restrictive because they perceive SEPAs as less well managed businesses than incorporated businesses?

We have offered a fairly lengthy and comprehensive explanation here about the intentions of the OTS in introducing SEPA, and the benefits. As to the question will be recommending SEPA rather than incorporation, the answer is that it is unlikely we’d recommend SEPA over incorporation. Yes, SEPA offers a certain level of protection, but SEPA may never win wider acceptance with banks, investors, stakeholders, and clients; it seems not to offer the benefits to businesses that incorporation does. Why, then, should businesses go for second best when a limited company, that is, incorporation, has an already proven history as the best model for those with serious intention to succeed in business?