You may already be self-employed, running a small business as a sole trader, or evaluating options for a new business idea you have. Whatever stage you’re at, it is worth considering forming a limited company. This type of business structure has several advantages attached to it – limited liability for company debts being the primary one.
When operating as a limited by shares company, the financial liability of the owners (aka ‘shareholders’ or ‘members’) is limited to the nominal value of their shareholdings. Therefore, if a company issues 100 ordinary shares, each with a nominal value of £1.00, the collective liability of the shareholders is limited to £100.
When operating a limited by guarantee company, however, the liability of the owners (aka ‘guarantors’ or ‘members’) is limited to the amount they ’guarantee’ to pay towards the company’s debts, if required. This is because this type of limited liability company does not have shareholdings.
In contrast to the limited company structure, sole traders and partners working within a traditional partnership are personally liable for all debts if the business gets into financial trouble.
Tax efficiency is not far behind limited liability in terms of advantages. The likelihood is that you’ll pay less personal tax as a director-shareholder of a limited company than you would as a sole trader or a partner within a traditional partnership.
Whether you end up paying less tax or not, one thing is certain – you will enjoy greater flexibility in your tax planning with a limited company than you would operating as a sole trader. So, what’s the fundamental difference?
In a nutshell, a sole trader pays Income Tax as well as Class 2 and Class 4 National Insurance contributions on all taxable business profits. The rates of Income Tax are 20% (basic rate), 40% (higher rate), and 45% (additional rate).
By contrast, limited companies pay Corporation Tax at 19% if they have annual profits of up to £50,000; 25% if their annual profits are greater than £250,000; or ‘Marginal Relief‘ rates between 19-25% if their annual profits are between £50,000 and £250,000.
Additionally, with regard to withdrawing money from a limited company, director-shareholders can do this in three ways:
- as a salary through PAYE
- by taking dividends
- as a director’s loan.
These options provide a number of opportunities for implementing effective tax-planning strategies.
A common practice is to take a minimal director’s salary each month to cover personal bills and living expenses, combined with a higher sum of money withdrawn from the company each quarter in the form of dividends.
This strategy legally minimises Income Tax and NI contributions because dividends are subject to dividend tax, which is only 8.75% for basic-rate taxpayers. There is also a £1,000 tax-free dividend allowance, which further reduces the overall personal tax liability of director-shareholders.
Another limited company tax benefit is to withdraw money in the form of a directors’ loan. This is tax-free, provided the loan is repaid within 9 months of the end of the company’s accounting period.
There is also more scope to offset business expenses against profits through a limited company than as a sole trader, which would enable you to further reduce your tax bill. However, we would recommend that you speak to an accountant with regards allowable expenses.
Separate legal entity
When you register a limited company, your business becomes a separate legal entity that is entirely distinct from you. This means that:
- your company will have its own legal personality
- all business income will belong to the company
- all business debts beyond the limited liability of members will be the responsibility of the company
- it will have its own credit score
- it will be able to enter into contracts and hold property and other assets in its own name
Third parties, therefore, will enter into contracts with your company – not you as an individual. This creates a level of security, particularly in relation to privacy and finances.
Reputation, credibility and trust
The reputation, credibility, and trust that arise from trading as a registered company inspires confidence in customers, suppliers and potential investors. Indeed, many larger companies simply refuse to deal with any business that is not incorporated at Companies House.
These benefits primarily come from the fact that anyone dealing with a registered company knows implicitly of the reporting and transparency obligations that exist under the Companies Act 2006.
In many ways, a sole trader entity is viewed as a one-person business with no formal structure, which may raise concerns with regards longevity and trustworthiness. It’s an unfair assumption, but it is a common one nevertheless.
How much does it cost to form a limited company and how long does it take?
The cost of forming a limited company through Quality Company Formations ranges from £11.99 for the Basic Package to £129.99 for the Fully Inclusive Package, which includes hardcopy documents, a London registered office, a director’s service address, a business address, and VAT Registration, plus much more.
It will take you approximately 5 to 10 minutes to complete your order, which involves choosing a company formation package and entering your company details on the online application form.
Companies House usually takes about 3 to 5 working hours to register a company; however, this is subject to workload and it could take up to 24 hours.
After company registration, you will have to pay £13 to Companies House when you file a Confirmation Statement every 12 months. You will also need to submit company accounts each year.
Whilst you will not have to pay any filing fees, you may benefit from using the services of an accountant. This will likely be a bit more expensive because company accounts are often more complex than sole trader accounts.
Who are Companies House and what is their role?
Companies House is the UK’s registrar of companies and the official governing body responsible for incorporating companies, collecting and storing company information, and making this corporate data available to the public. As an executive government agency, Companies House also enforces corporate compliance under the Companies Act 2006.