Publicising profitability - proposed changes affecting small businesses - Forvis Mazars

There are several policy objectives to the Bill, primarily aimed at increasing the transparency and useability of the information submitted to Companies House, with the laudable aim of making the UK less accessible to those individuals who would seek to abuse the UK’s financial system to hide their dirty money. One aim of the Bill, as part of a wider reform of Companies House, is to improve the reliability of financial information on the register, enabling better business decision making.

Accounts filing options for small and micro companies

Presently, a small and micro company have several options regarding the filing of their annual accounts at Companies House. Both small and micro companies can benefit from “filleting” their accounts prior to filing. This filleting process removes the Directors’ Report, and the Profit & Loss Account, including any associated notes. The small, or micro company is therefore able to keep private their gross and net profit, their margins, and details with respect to dividends paid to their owners.

As a business owner there may be many reasons why they would wish for this information to remain private.

Consider employees of the small or micro company. Would it interest them to see how much profit their employer was making, and how much they were paying themselves in dividends?
What about a competitor? Would they be interested in benchmarking their profit margins against the competition? Would this information enable an aggressive pricing strategy to undercut a rival, to gain a wider market share?
Or would this information be useful to a key supplier, or customer of the small or micro company? Could this lead to a customer requesting a renegotiation of a contract due to the profits they’ve seen being made?

The above-mentioned concerns were behind the original purposes of allowing such companies to benefit from reduced disclosures, and it’s our experience that most companies do utilise the reduced disclosure, why wouldn’t they?

Aims of the changes proposed

The Bill proposes a sweeping change which will affect every small and micro business, making their financial affairs even more visible to the public and interested parties, by removing the ability to fillet accounts and requiring full accounts to be filed. All the information previously excluded would now be visible from a search of the accounts of the company filed at Companies House.

Fraud prevention

The limited liability protection provided by a company to its owners and directors is considered to be abused by fraudsters taking advantage of the current lack of transparency. The primary stated aim of the Bill is the prevention of such fraud. By requiring small and micro companies to file their Profit & Loss Account, the hope is, that this will lead to the easier detection of fraud when it happens.

ii) Better-informed decisions

The UK Government believe that by requiring the small and micro company to file their Profit & Loss Account, this will provide more information to users to make better-informed decisions. They believe that it will make it easier for lenders and creditors to assess creditworthiness.

There’s no argument here, it obviously will, however, it is likely that lenders currently request such information directly from the company to allow them to assess creditworthiness. Having more information in the public domain assists the lender in this respect, but little more than that.

The proposals would allow a member of the public to assess the creditworthiness of a small or micro company before they entered a contract for goods or services, for the customer this could be beneficial. It would be interesting to see whether following the implementation of the proposals this significantly increased the number of visits to Companies House’s website.

Finally, there will be much greater information available to the credit-rating agencies, and therefore we would expect movements in “credit-scores” to be easier to understand.

Timetable and Actions?

Since 22 September 2022, the “Bill” has been making its way through Parliament. Companies House have started to publicise the changes here, but as yet there is a lack of detail in the announcements.

The timing of the introduction will depend upon its path through Parliament, and the first Year End Accounts to which it will apply may yet be a year or so away, but it is still an important consideration for now. If a business is starting up or restructuring, then the likely impact of these changes needs to be understood. For an existing business not planning on any significant changes, then it is more a consideration of what your options are should you be concerned about the impact of the additional disclosure.

Due to the privacy issues presented by the implementation of the Bill, there may be increased interest in retaining a greater level of confidentiality of the performance of your business, for which there are two options, namely changing the status of your company to an Unlimited Company or dis-incorporate your business to become a sole trader or partnership. With both of these options the loss of limited liability is the primary disadvantage, as being subject to unlimited liability means that where the business fails to pay its debts, upon winding up the owners are personally liable to contribute to the assets to satisfy the debts and other expenses of the winding up process.

i) The “Unlimited” company

The main benefit of running an unlimited company is that they are exempt from filing annual accounts with Companies House, thus maintaining the company’s financial privacy.

Unlimited companies also benefit from greater flexibility in relation to dealing with its capital as they can carry out capital reductions without court approval or a solvency statement and can buy back or redeem its shares without many of the restrictions under the Companies Act.

ii) Sole-trade or Partnership Structures

This means effectively reverting to being self-employed, either as an individual or within a partnership. There are no filing requirements at Companies House and that element of compliance falls away, with the primary focus being on keeping suitable account for the owners and for HMRC.

This latter point is key as the tax regime now differs significantly. Historically, the general principle has been that it has been more tax effective to trade through a company, with low salary and dividends used to extract profits. With the increase in Corporation Tax rates to 25% these corporate advantages have largely been eroded and therefore the structure question is far less clearcut from a tax perspective.

To summarise

The Bill is a laudable attempt to reform Companies House and make the information held more transparent to the user. However, as discussed above, there are problems with this approach for the small and micro company and their owners. Business is ever more global, and competitive, and with the current economic environment, and increasing fiscal parity with the unincorporated business model, for some, these changes could prompt consideration of whether the corporate model is still appropriate for their business. The unlimited company could provide a solution to some. However, without the protection of limited liability and the reduced advantages from a tax perspective, we could potentially see more businesses adopting the unincorporated model in the future.