What do you need to know before incorporating a Limited Company

When starting a business it is important to understand what business type you should adopt.  This article cover what a Limited Company is along with the pros and cons of being such.

We will only cover the most common type of Limited Company which is a Close Company, meaning it is effectively owned and managed by its shareholders (up to 5 people).

What is a Limited Company?

A Limited company can be limited by shares or by guarantee.  The vast majority of companies are limited by shares, which we will assume throughout.

A Limited company is effectively a person as it has its own legal identity.  This is important to know, as many people think the money in the company is theirs to take freely.  It is, to a point, but there are specific rules governing how you can do so.

How do you register as a Limited Company?

There are various ways by which you can do so yourself. However, even though you can do it yourself doesn’t necessarily mean you should do.

We often see that those who have set up their own company have made errors, meaning we have to spend time correcting them, resulting in higher costs.  Commonly, Directors have signed up to expensive Registered Office services, which your accountant would provide for free.

There are things to consider when setting up a company so we would always recommend seeking professional advice.

What is my potential Liability?

A Limited company has limited liability.  Liability is limited to the reserves remaining in the company and the shares that have been purchased.  This means that your personal assets are safe, unlike a sole trader, thus providing a protective veil.

The veil can be lifted and creditors can pursue shareholders, but this is rare and is due to some form of wrongful trading or where personal guarantees are provided.

What taxes are there to pay?

A company pays Corporation Tax on the profits it makes.  The Corporation Tax rates from April 2023 are 19% up to £50k and 25% from £250k.  In between these two bands the effective rate is 26.25%, as the rate moves from 19% to 25%.

Once the company has factored in the Corporation Tax it has to pay, the leftover profit is classed as retained earnings.  A company can pay dividends to its shareholders from the retained earnings.

The tax on dividends is at 0% (up to £2k), 8.75% (basic rate), 33.75% (higher rate), 39.35% (additional rate).

How should I remunerate (pay) myself? Salary or Dividends?

Most people think that they should pay themselves dividends only from a Limited Company as it will save tax.  However, this is not necessarily the best approach.

Dividends are not deductible for tax, but a salary is.  In addition, you want to earn a salary as that will earn you a qualifying year for state pension purposes.

If you have a salary at the Personal Allowance and National Insurance level (£12,570) the company will save 19% in Corporation Tax = £2,388.30.  There will be some Employer’s National Insurance due: £12,570 – £9,100 @ 13.8% = £478.86, but this will be tax deductible making the cost £387.88 (using 19% tax relief).  If you had other employees you may not even have any Employer’s National Insurance.  Overall, by having a salary, the net tax saving is £2,000.42 and the overall tax suffered is £387.88

There are some costs for monthly payroll and set up fees, but these are far outweighed by the tax savings.

If you had just taken out Dividends only of that amount the company would pay tax of £2,388.30, before dividends tax of £924.88 (£10,270 @ 8.75%), meaning the overall tax suffered is £3,313.18.

I have another job so I use up my personal allowance

People often think that as they have another job (or they are a higher rate taxpayer) they should only take dividends.  Again this is not right!  If you have a salary of up to the Personal Allowance and National Insurance level (£12,570) the company will save 19% in Corporation Tax, but you will pay tax at 20% (basic rate), 40% (higher rate), 45% (additional rate).  This means the effective rate is 1% (basic rate), 21% (higher rate), 26% (additional rate).

These effective rates are all lower than the Dividend tax rates 0% (up to £2k), 8.75%, (basic rate), 33.75% (higher rate), 39.35% (additional rate).  Plus don’t forget you are also paying Corporation Tax at 19%.

Why do you suggest paying Employer’s National Insurance?

Some think why pay Employer’s National Insurance?  I am paying tax unnecessarily.  That is correct, however, the company is paying tax at 13.8%, but the company is saving 19% of this making the effective rate 11.18% and you are saving tax at 19% between the Employer’s threshold of £9,100 to the Personal Allowance and National Insurance threshold at 19%.  As a 19% saving is higher than an 11.18% payment it makes sense to pay some Employer’s National Insurance.

The benefits of a Limited Company
  • Limited liability gives the shareholders protection. Banks can still ask for personal guarantees however, which can remove this protection
  • Your company has a name registered with Companies House which helps to protect it from other businesses trying to use the same name
  • Increased credibility, as your business can appear larger, however, your records are available and you have to detail number of employees in your accounts
  • It can be tax efficient to be a Limited company, especially if you do not require all the profits to live off
  • It can be easier to raise capital as there is more governance
  • You have the option to offer company shares to your employees, which may motivate them more and gives the chance to have a say in how the business is run.
The downsides of a Limited Company
  • It is more costly to set up and run a Limited Company
  • The assets are not yours, they are the company’s. You need to ensure you do not take out more than the available reserves, as there are penalty taxes if you do. Also if you use company assets they could be taxable
  • Expenses must be in the business name e.g. a mobile phone contract
  • Corporation Tax when there are associated companies
  • There is more administration. The bookkeeping and accounting of a Limited Company is more complex
  • Private Limited Companies (Ltd) can’t trade their shares with the public as a way to boost capital
  • Directors and Shareholders may not agree on how the business is run as well as how to implement new ideas
  • Publicly available information on Company House removes an element of the privacy
What is my year end and deadlines?

A Limited Company has 4 effective deadlines:

  1. The accounts for Companies House need to be filed 9 months after the year end. Please note the year one filing deadline is therefore 21 months after the incorporation date
  2. The annual Confirmation Statement where you update the company details held
  3. The Corporation tax deadline is 9 months and 1 day after the accounting period end date.  If the profits are above £1.5m to £20m and £20m+ click on the links
  4. The Corporation tax return filing date is 12 months after the accounting period end date

It is important to meet the deadlines otherwise there are fines:

When do I pay tax?

The answer was above – 9 months and 1 day after the accounting period end date, however, it can make sense to pay the Corporation Tax early.  The reason why is HMRC pay interest, which is often higher than the interest rate of the bank account where the money is being kept.

Contact us

This article is only generic advice and not tax-specific.  Tax laws change and this can affect parts of the article, so you should always obtain professional advice.  It is not exhaustive, but covers some of the important aspects of having a Limited company.  If you are thinking of starting a business and want to discuss which option is appropriate for you please contact us and a member of our team will be happy to help.

Leave a Comment