You may already be self-employed, operating as a sole trader, or you may simply have an idea and you’re considering your options. Whatever stage you are at, it is worth considering forming a limited company, which has several advantages attached to it – limited liability being the primary one.
When operating as a limited company, the owners’ (shareholders or members) liability to the debt of the business, is limited to the nominal value of their shareholding in the company. Therefore, if a company has a shareholding of 100 ordinary shares, each with a nominal value of £1.00, the total liability of the shareholders is limited to £100.
The above example applies to a limited company, what is known as a private company limited by shares; however, limited liability also applies to companies without a share capital – known as companies limited by guarantee. In such cases, the members’ liability is limited to the amount they agree to ’guarantee’ the company’s debts.
In contrast, should a business run into financial trouble, sole traders and partners working within a traditional partnership, are personally liable for all business debts.
As advantages go, tax efficiency is not far behind limited liability — as the likelihood is, you’ll pay less personal tax as a director / shareholder of a company, than you would operating as a sole trader or 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, Class 2 and Class 4 National Insurance contributions on all taxable profits of the business. No other options are available. By contrast limited companies pay corporation tax at a flat rate of 19%, which is lower than the rates of income tax in UK, which start at 20%, and rise to 45% for higher earners.
Also, with regards withdrawing money from a limited company, director / shareholders can do so by three means: salary (PAYE); dividends and directors’ loans.
A common practice is to take a minimal salary to cover personal monthly overheads and bills, and then most money is withdrawn from the company in the form of dividends (taxed at 7.5% for basic rate taxpayers), which reduces income tax and NI contributions. There is also a £2,000 tax free dividend allowance which further reduces the overall tax liability.
Another limited company tax benefit is to withdraw money in the form of a directors’ loan – which is tax free (provided the loan is repaid within 9 months of the accounting period end).
It is also worth mentioning there is usually more scope to offset business expenses against profits through a limited company than as a sole trader, and so further reduce tax payable; however, we would always recommend you speak to an accountant with regards allowable expenses.
Separate legal entity
When you register a limited company, you become a separate legal entity from the company you form. Once your company exists, it has its own financial records, credit score, assets and property.
Third parties, therefore, enter into contracts with your company, not you or any directors or shareholders as individuals, which in turn creates a level of security, particularly in relation to privacy and finances.
Reputation, credibility and trust
There are reputational benefits that arise from trading as a registered company, which inspires confidence in customers, suppliers and potential investors. Indeed, many larger companies will simply not deal with a business which is not incorporated and registered 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 which is exist under the Companies Act 2006.
In many ways a sole trader entity is seen as a one-person business with no formal structure, which may raise concerns with regards longevity and trustworthiness.
How much does it cost to form a limited company and how long does it take?
The cost of forming a limited company with Quality Company Formations starts at £12.99 for the Basic Package and rises to £89.99 for the Complete Package which includes hardcopy documents, 3 company address services for one year, and VAT Registration.
With regards timescales, it will take you approximately 5 to 10 minutes to complete your order, which includes choosing a package and entering your company details. Companies House usually take between 3 to 5 working hours to register a company; however, this is subject to workload and it could take up to 24 hours.
One word of caution – please bear in mind, the cost of preparing and filing annual accounts at Companies House for a limited company (which you will likely require the services of an accountant) , will most probably be more expensive than you would pay for a set of sole trader accounts which do not need to be filed at Companies House.
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 registering companies, company information and making it available to the public. It is also an executive government agency, which enforces compliance under the Companies Act 2006.
What happens if I don’t register a company?
If you do not register your business, you will be operating as a sole trader or traditional partnership and you will not enjoy the benefits of a registered limited company.