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5 min read

Should I set up my business as a limited company?

Starting up in business as a limited company has many benefits, including tax advantages and reduced risk. This article will give you a broader understanding of limited companies and your responsibilities when setting one up.

What is a limited company?

A limited (or limited liability) company is a structure that you can use to run your business – it’s responsible in its own right for everything it does and its finances are separate to your personal finances.  

As a separate legal entity it can enter into contracts in its own name. Business dealings are made on behalf of the company, rather than the owners. Its owners are protected by limited liability. This means they are only responsible for business debts up to the value of the amount they invested.

Any profit it makes is owned by the company, after it pays Corporation Tax. The company can pay out its profits (after tax) to its shareholders in the form of dividends. 

The company must have at least one director to manage the business and a company secretary to make sure all the rules are followed and official records maintained.

Why should I choose a limited company?

The advantages of setting up a limited company are:

  • the liability for shareholders is limited
  • shareholders (often family members) can be employed by the company
  • taxation rates can be more favourable
  • you’ll have access to a wider capital and skills base
  • Improved status externally.

Disadvantages include:

  • the reporting requirements can be complex
  • there are more costs to set up 
  • the company must incorporate with Companies House
  • the companies financial affairs are public
  • if directors fail to meet their legal obligations, they may be held personally liable for the company’s debts.
1:33

Video: Should I register as a limited company or a sole trader?

by Informi

This video explains the benefits of trading as a limited company, explaining the differences between sole traders and limited companies and the various ways that a limited company can protect small business owners and inspire confidence in their businesses.

How do I earn income from a limited company?

As a director of a limited company, you can take money from the company in three ways:

  • Salary, expenses and benefits
  • Dividends
  • Directors loans.

A new dividend regime came into effect from April 2016 in the UK. Under the new regime, everyone will be entitled to a dividend allowance which means the first £2,000 of taxable dividends will be taxed at 0%.

Any dividends in excess of this will be taxable at new rates.

Tax band Tax rate
Basic rate 7.5%
Higher rate 32.5%
Additional rate 38.1%

Dividends are not allowable expenses and so the company does not get relief on them.

Certain expenses are allowable to the business such as salaries paid to the directors and benefits paid by the company to the director but there will be tax issues and national insurance considerations here.

Certain benefits/expenses

  • Entertaining employees/directors at annual functions (rules apply)
  • Payments into directors’ pensions
  • Mobile phone (rules apply)

The following benefits also apply.

  • Rental income

    Where a company uses equipment or a property which is personally owned by a director, rent can be charged from the director to the company. You should speak to a professional so they can best advise you.

  • Interest

    If the director loans the company money (or has a directors’ loan account in credit) the director can charge the company interest on the loan. Again, you should speak to a professional so they can best advise you.

  • Salary

    A salary can be paid to the director. Where a company does not exceed £8,164 a year as a salary to each director, there will be no national insurance contributions and the director will still receive state pension credit for that period as long as they are paid above the lower earnings limit. A payroll professional can advise the ideal salary to pay directors.

What tax will I pay?

It depends on how you acquire your funds. If you take a salary through your company this will be treated as normal income, and the usual 20%, 40% and 45% tax rates will apply. If you make pension contributions from the company into the director’s personal pension, then this will be an allowable expense to the company and will not be taxed on the director until he starts to draw on it, so many directors see this as an attractive option.

Salary, benefits and rental income are all treated as non-savings income and will be taxed first using the normal income tax rates. Interest will be taxed next. There is a potential to tax £5,000 of interest at 0%. There are conditions here and you should speak to a professional to see if you are eligible for this 0% rate.

In terms of dividends, the first £2,000 of dividends are tax-free with the remainder being taxed at 7.5%, 32.5 or 38.1% where dividends fall in the basic, higher or additional thresholds.

What are my responsibilities as a director of a company?

As a director of a limited company, you must:

  • try to make the company a success, using your skills, experience and judgment
  • follow the company’s rules, shown in its articles of association
  • make decisions for the benefit of the company, not yourself
  • tell other shareholders if you might personally benefit from a transaction the company makes
  • keep company records and report changes to Companies House and HM Revenue and Customs (HMRC)
  • make sure the company’s accounts are a ‘true and fair view’ of the business’ finances
  • file a Company Tax Return and pay Corporation Tax
  • register for Self-Assessment and send a personal Self-Assessment tax return every year – unless it’s a non-profit organisation (e.g a charity) and you didn’t get any pay or benefits, like a company car.

You can hire other people to manage some of these things day-to-day (e.g an accountant) but you’re still legally responsible for your company’s records, accounts and performance. You need to ensure you are organised. There are penalties for failure to submit corporate tax returns and accounts. You also need to ensure you keep all of your paperwork such as dividend vouchers.

Company accounts are complicated, it’s best to work with an accountant. Usually, accountants will quote you an annual fee which includes all the company regulatory and compliance work and your personal tax returns too.

What are my risks if the business fails?

Although the directors of a limited company are not normally held liable for the debts of the company, frequently the courts on behalf of the creditors can deem one or more of the directors liable for the company’s debts during a formal insolvency procedure. The rules are complex here and professional advice is recommended.

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