A limited company is a separate legal entity from its owners and is therefore taxed separately. Depending on the circumstances, this can potentially create advantageous tax saving opportunities, but there are also disadvantages to consider too.
We can help you decide whether setting up a limited company would be worthwhile and guide you through the process of doing so.
Potential advantages of a limited company
When you set up a limited company, you become a director of the company and normally an employee. Depending on your circumstances, a tax saving can be made by paying less National Insurance Contributions (NICs). By paying yourself a nominal salary (normally up to your tax free personal allowance) and taking the remaining company profits as a dividend at the end of the year, you could pay less tax and NICs. As a director, you can also benefit from other tax free payments that can be made to employees.
If your taxable profits are high, it could possibly be more tax efficient to operate as a limited company instead of a sole trader. The same applies to partnerships, although your total combined profits will need to be higher in order for it to benefit you.
By setting up a limited company, you also have the option to restrict your income by not paying yourself a dividend in a particular year. This could be useful for other tax planning opportunities as your income will actually be less in that year.
The directors of the company have limited liability. This means that if the company fails, the directors can only lose their original investment in the company. When a company is set up, the directors purchase shares in the company and if the company fails, their total loss would only be the value of the shares they bought in the company, plus any loans they made to it. However, in reality most lenders of finance will probably want personal guarantees from the directors in case the company fails.
Trading as a limited company may add a certain credibility to the company and help the company attract new customers or suppliers. However, it is worth noting that a newly established limited company will not have any trading history or credit history and this may prove to be a disadvantage at times.
Potential disadvantages of a limited company
If you are just starting out in business and expect to make losses in your first four years of trading, you can offset self employment losses against other income, perhaps from a former employment, in the same tax year or the previous three tax years, instead of carrying the losses forward to offset against future profits that may never materialise. You cannot offset losses from a limited company against your personal tax, therefore trading as a sole trader or partnership may be more advisable in the early years.
There is an increased administrative burden of operating as a limited company. Statutory records must be kept, annual accounts filed at Companies House and a corporation tax return must be completed in addition to self assessment returns for the directors. You can therefore expect your administrative and accountancy costs to be substantially higher. It will depend on your circumstances as to whether these additional costs will be offset by any potential tax savings.
You cannot draw money out of the business in the same way as a self employed person can do. The company must pay you a salary through the PAYE system and you can only pay yourself a dividend if the company generates profits. There may be serious financial penalties and tax implications if you do not strictly manage your cash withdrawals from the business.
There can be other complications when transferring certain assets into the company name. Transferring land and buildings into the company will create legal costs and may attract stamp duty. You will also lose the ability to utilise your personal annual allowance for capital gains tax when the company disposes of the property. It can therefore often make sense to leave some capital assets outside of the company, although this can have other tax implications too.
Cars owned by a company and used by a director will create a taxable benefit in the hands of the director. It can therefore often make sense to leave cars outside of the company and claim mileage allowances instead. However, you will lose the right to claim capital allowances and running costs by doing this.
If you are caught by the IR35 legislation for Personal Service Companies and partnerships, it may not be beneficial to trade through a limited company. This legislation applies to those who offer their services to a client through a third party (eg a company) and the engagement is comparable to that of an employee. We can help you to decide if this legislation applies to you.
A formal procedure must be followed to close down a company. This can be expensive if the company becomes insolvent and has to be closed down by a professional liquidator.
Limited liability partnerships (LLPs)
LLPs can sometimes be a suitable business structure for individuals who want to continue to be taxed as a self employed person but require limited liability from debts or negligence claims etc.
LLPs are regarded as 'bodies corporate' and subject to aspects of company law but are not taxed under the corporation tax regime. They must however still file accounts at Companies House and keep statutory records. We can help you decide whether an LLP or other form of partnership might suit your circumstances.
This information is not meant as a substitute for professional advice and by no means covers every scenario. Almost every rule described here will be subject to many exceptions and caveats. Tax legislation is extremely complex and can be difficult to understand. You should discuss your circumstances with a qualified professional before acting on any information contained within this website. Tax legislation is constantly changing and the information contained within this website is written from our current understanding and interpretation of the tax system as of 6 April 2020.