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.

TaxAgility 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 TaxAgility. 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 TaxAgility, 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.