Incorporating a limited company
Choosing to set-up a limited company is a popular choice in the UK. This post explains what is a limited company and shares how it can maximise your take-home pay, along with other advantages and disadvantages.
If the time has come and you are considering setting up a business, chances are, you have been made aware of the different types of company structure in the UK. It is even possible that your friends and associates are encouraging you to set up a limited company. Among the many reasons you hear pertaining to a limited company, these three main points are likely to stand out:
- Your liability as a shareholder is limited.
- Taxation rates can be more favourable.
- You can be tax-efficient by taking a low salary and using dividends to make up your income.
But a limited company is not without its disadvantages and we must emphasise that your approach to tax must also be right and lawful, as HMRC can and do challenge company directors. It is with this in mind that our small business accountants want to share the ins and outs of incorporating a limited company so you have an idea if this is the right business structure for you.
What is a limited company?
Governed by the Companies Act 2006 and its own articles of association, a limited company is a legal entity with its own legal rights and obligations, a distinct advantage that is welcomed by most business owners.
Essentially, what it means is that the company can enter into contracts, receive income, own property, pay tax, employ people, sue and be sued. The rights and obligations of the company are separate from its shareholders, directors and employees. In the event that the company is insolvent, the directors are only liable for the amount they have invested in the company and are not held responsible for the company debts incurred in the ordinary course of business. The only exception is when the directors fail to meet their legal obligations and they do look out for the interests of the company, but that does not happen often as most directors do exercise a duty of care.
A limited company can be large with multiple employees or set-up with just one individual as the sole director of the company. A large number of contractors and small business owners prefer to set-up a limited company of their own as it probably is the most efficient method to maximise your take-home pay. The approach is to channel income through your limited company and paid out to you (and/or any other shareholders) in a combination of salary and dividends. This can result in tax savings, as dividends are treated differently to salaries in terms of tax.
Having said that, we advise contractors to have a chat with one of our contractor accountants to determine if you fall within or outside the IR35 rules.
Now let’s use some examples to illustrate how incorporating a limited company can boost your take-home pay.
Scenario 1: You are the sole director and your salary is £40k a year
In this scenario, you are the director and also the employee. You receive an income of £40,000 a year. In the tax year 2019/20, this means your take-home pay is about £30,736 as any salary calculator website can quickly tell you.
Scenario 2: You are the sole director. Your salary is £10k a year and you declare a dividend of £30k.
In this scenario, you are the director and also the employee. You receive a low salary of just £10,000 a year. To make up your income, at the end of the year after your company has paid company tax on the revenues, you declare a dividend of £30,000. As you are the sole director, you receive the full sum of the dividend. In the tax year 2019/20, this means your take-home pay is £37,923; this is £7,187 more than the previous example.
The above examples are simplified for discussion only. In reality, how much tax you pay depends on your circumstances. Nonetheless, it does illustrate to you why contractors and small business owners prefer to set-up a limited liability company. If you would like to know more about dividends, this post “Understanding dividends” is packed with information.
Other benefits of having a limited company
- You can easily transfer ownership by selling shares to another party, this is particularly useful if you have an exit strategy in mind.
- Shareholders (often couples or family members) can be employed by the company and reduce the overall family tax obligations.
- A limited company looks more professional than a sole trader and if you are looking for funding, investors are more likely to invest in a limited company than a sole trader too.
- It can fund pensions as a legitimate business expense.
- Once you have registered your company, no one else can use the same name as your company.
Now the disadvantages of having a limited company
Everything has two sides and before you rush to incorporate a limited company, it pays to take a second to understand the disadvantages.
- It can be expensive to establish and maintain a limited company.
- The reporting requirements are complex and best handled by an experienced small business accountant. This will free up your time to focus on your business.
- The company pays tax on the profits.
- When the company declares dividends, you and your shareholders are responsible for pay tax on them, despite dividends have lower tax rates than salary.
- The financial information of the company is made public by Companies House.
- If any of the directors fail to meet their legal obligations, they may be held liable for the company’s debts.
Tax Agility can help you to incorporate a limited company
Before making a decision on how you should go about incorporating your company, it is best speaking to a qualified and independent small business accountant like our team here at Tax Agility. The reason is simple – there will be areas like VAT, tax incentives/ relief (such as the Annual Investment Allowance), cash flow management, and general financial control that we can assist you with and give you and your business the best chance to succeed.
At Tax Agility, we have been championing small businesses across Putney, Richmond and Central London for many years now. As everyone has a unique situation and aspiration, our personalised package starts from £105 per month + VAT. This means you can engage our service and use us as your financial controller without paying big money.
So let’s kick-start the conversation today. We are available on 020 8108 0090 or you can contact us online to arrange for a complimentary no-obligation meeting.
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This post is intended to provide information of general interest about current business/ accounting issues. It should not replace professional advice tailored to your specific circumstances.
Limited Company or Umbrella Company – which is right for you?
If you’re looking for a career change and have decided to work for yourself, Tax Agility’s accountants can advise you on the best contracting option for your business.
Before starting out as a freelancer or contractor, it’s worth taking some time to decide if you should set-up a limited company or register with an umbrella company.
Deciding which route to take often comes down to your requirements, the level of control you want, your long-term business strategy and the type of operations that you'll be undertaking.
At Tax Agility, we believe that there is no right or wrong decision when it comes to choosing between a limited and an umbrella company. If in doubt, our expert accountants for contractors can help you understand what your business requires to determine the best course of action for you. With years of experience in helping contractors across London, we can provide you with solid guidance and advice so that you can make an informed decision.
Contracting through a limited company
A limited company is a type of business whose legal standing is independent of its shareholders and directors. Setting up a limited liability company can take only a few hours. It involves choosing a name for your company, submitting the required documentation to Companies House, and registering with them once the documents have been approved.
Setting up your own limited company means that you are in control, and your personal finances will be separate from your company’s finances. In the event that something goes wrong with your company, your personal finances will not likely to be affected. However, it is also important to understand that setting up a limited company means that you will be in charge of managing your administrative and legal obligations for the company.
Is a limited company the right option for you?
If you are planning on contracting for a long period of time, a limited company could be the most tax-efficient way of working – as it allows you to claim various expenses and pay yourself a combination of salary and dividends (a sum of money that a limited company pays out to someone who owns shares in the company, i.e. a shareholder) to benefit from the tax free allowances available to each. You can also make tax-free pension contributions through the company and leave funds within the business to grow and expand.
On the other hand, a limited company is costly to set-up (more so than registering with an umbrella company). Also, there is some administration involved in running a limited company even with an accountant for contractors supporting you. For example, you will need to keep track of your income and expenses, such as receipts and invoices, as the information is required for the submission of your year-end accounts and tax returns.
It is worth noting that if you fall within the IR35 legislation, the tax benefits of a limited company will completely disappear. IR35 is a tax legislation that is designed to combat tax avoidance by workers supplying their services to clients via an intermediary, such as a limited company, but who would be an employee if the intermediary were not used. By falling on the wrong side of IR35 due to your working arrangements, you can end up paying tax and National Insurance at the same rate as a permanent employee. To understand more about the IR35 legislation, you can check out this post, What does IR35 legislation mean?
Contracting under an umbrella company
Contracting under an umbrella company means that you are considered an employee of the umbrella company. You will need to submit timesheets to the umbrella company which will then invoice the end client or agency for the work that you have completed. In terms of salary, you will be paid as a PAYE (Pay As You Earn) employee minus the umbrella fee, which the company will charge each time you receive a payment. Contractors who prefer no administrative duties generally favour this type of contracting route.
Is an umbrella company the right option for you?
An umbrella company frees you of all the administrative and financial responsibilities that come with being a contractor, meaning that you don’t have to manage or pay your taxes or National Insurance, allowing you to focus on your work.
You will work under a form of employment contract, which still guarantees you the benefits offered to permanent employees, such as holidays, sick leave, maternity and paternity pay.
However, the biggest disadvantage of working with an umbrella company is that they charge a substantial sum of administrative fee, as they take care of your timesheets, billings, PAYE and National Insurance. As such, this option is only suitable for contractors who are new to contracting or work on short-term contracts.
Tax Agility accountants for contractors
Before taking the leap into contracting, contact one of Tax Agility’s specialist accountants for contractors and discuss the options that are best for you given your individual circumstances.
It is also worth checking out these pages written specifically for contractors:
If you choose to set-up a limited company, we will work with you to ensure that you understand what is required of you in terms of your financial and tax obligations, so that we can try to maximise efficiency and minimise your tax obligation where possible. We can also assist you with registering with Companies House, and subsequently, assist you in bookkeeping and accounts so you can concentrate on your business.
If you are already a contractor and want to increase your take-home pay, need assistance with adhering to regulations (such as IR35), or help with your ongoing accounts and bookkeeping, contact us today on 020 8108 0090 or get in touch via our contact us page to arrange a complimentary, no obligation meeting.
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This post is intended to provide information of general interest about current business/ accounting issues. It should not replace professional advice tailored to your specific circumstances.