Many people who either are looking to start their own business, or are a contractor or freelancer looking for a payroll solution, hear that limited companies are a tax-efficient way to operate in the UK. But with all the confusing jargon surrounding it, what is a limited company really and how can operating one benefit you?
There’s no real easy way of describing a limited company, but to put it as simply as possible, a limited company is a legal business structure that is incorporated through Companies House and provides limited personal liability. Having limited liability prevents its owners from being legally responsible for its debts, except for the amount that they invested into said business.
The owner/owners benefit from limited liability of debts and losses of the company, hence the term ‘limited’ company. After paying Corporation Tax, a limited company can keep any profits it makes and distribute it to the company owners and directors as dividends and expenses.
The rules and regulations set by the Companies Act 2006 govern public and private companies in the whole of the UK, including limited companies. Limited companies are incorporated and dissolved through Companies House.
The most common types of limited company formed in the UK are: private limited by shares (LTD), private limited by guarantee (LBG), and public limited company (PLC).
A private limited company by shares is the most popular form of limited company in the UK and is particularly favoured by the self-employed.
This type of company is owned by shareholders who appoint directors, often themselves, to manage day-to-day business operations. A limited company by shares is a company whose ownership is made of shares which are distributed amongst the designated company shareholders. A private limited company by shares can have just one share or they can have thousands, depending on the class of share, shareholder investment and the number of shareholders in the company.
The profits generated by a limited company can, after Corporation Tax, either be retained in the company or distributed to the shareholders as dividends.
Most SMEs are private limited companies by shares and are the limited company structure of choice for individual contractors and freelancers.
A private limited company by guarantee is mostly used by people looking to set up a charity, club, society or other non-profit organisation. These companies usually will not distribute company profits to their owners or members, but choose to retain them or reinvest them into the business.
As with a limited company by shares, a limited company by guarantee is liable for its own debts, but it does not have any shares or shareholders. A limited company by guarantee is only liable for its own debts to the maximum ‘guarantee’ that is set out in its company articles. This protects the owners, or ‘guarantors’, who run the organisation from being personally liable if the company’s income does not meet its expenses.
A public limited company (PLC), is a type of limited company which has shares that are available to the general public for purchase. The shares are referred to as a company’s ‘stock’ and can be acquired by anyone either privately or through stock market trades.
A PLC is ideal for a business that requires an influx of capital, as they are able to sell ownership in the business, in the form of shares, to investors in exchange for share capital. A PLC is often a large business and may be listed on the London Stock Exchange and other global stock markets.
A PLC must be registered at Companies House, and must also have at least two shareholders, two directors (one of which must be an individual), a qualified secretary and shares available to the public which are at least £50,000 in value.
All types of limited companies must file a Confirmation Statement (formerly Annual Return) and statutory accounts yearly to Companies House.
Anyone can set up a limited company in the UK, provided that they:
- Are at least 16 years of age
- Have not declared bankruptcy that is un-discharged
- Are not subject to any UK government restrictions
- Are not restrained from operating a company by court order
Furthermore, at least one of the directors must be a person.
Yes - provided the above limitations don’t apply. As a contractor or freelancer, setting up and operating your own limited company can be a very tax-efficient way to be paid, and it is a very popular choice of payroll solution amongst the growing self-employed population in the UK.
Setting up a limited company could be an ideal option if you believe you will take on contract roles for the foreseeable future, as you can take your limited company with you to each contract or project you take on. Even if you move from contracting to permanent employment, you can make your limited company dormant to keep your options open for the future without closing your company down and having to go through the setup process again.
If you are already a contractor but work through an umbrella company, it’s also fairly easy to switch over to your own limited company, and a contractor accountant can help you do this.
In addition to limited liability, there are many benefits of limited companies such as:
- Tax efficiency – A director and shareholder of a limited company can opt to take a small salary and draw most of the available company profits as dividends.
Unlike salaries, dividends are not subject to employer or employee National Insurance Contributions, and the tax rate for dividends is lower. This helps to minimise the tax burden of a limited company director.
Furthermore, some costs that are incurred whilst doing business through a limited company can be claimed as expenses against pre-tax company profits. Travelling or eating out whilst working through a limited company could be claimed as Travel and Subsistence expenses, allowing the company a saving on Corporation Tax. There is a range of other expenses that are potentially claimable such as training costs, tools and equipment, mileage, annual work events, accountancy fees, etc.
- Professionalism and credibility – An incorporated business tends to look more professional, credible and reliable than, say, a sole trader who holds all personal liability for his or her losses. Some businesses will even refuse to work with unincorporated businesses, so having a registered limited company opens the door to a wealth of potential business and opportunities.
- Financial control – Besides holding back company income in order to pay Corporation Tax, PAYE, National Insurance and VAT, a director/shareholder of a limited company has control over the movement of company funds. In comparison a company employee is not able to touch their income until it has passed through their employer. A limited company removes this lack of control and gives the owner greater professional autonomy.
- Growth potential – Limited company shares can be sold to investors in exchange for capital, an option which is not available to unincorporated businesses. Furthermore, if the owners of a small limited company wish to expand the business, taking on more clients or hiring staff, the possibility is already there.
For many people, setting up a limited company and preparing it for trading is the hardest part. But there are some ongoing tasks that a limited company director must do as well, however some of the administration is fairly simple, such as creating invoices. The more tedious and complex tasks can be completed with the help of an accountant.
The main administration involved with running a limited company include:
- Drawing up invoices and billing clients
- Running payroll
- Completing bookkeeping
- Logging and claiming expenses
- Completing and filing annual statutory accounts
- Submitting a yearly Confirmation Statement to Companies House
- Completing a yearly self-assessment
- Submission of an annual tax return and payment of taxes – Corporation Tax, PAYE, VAT (if registered) and personal tax
Many who are looking to start out on their own may be intimidated at first by what’s required of them as a limited company director, however there are specialists out there to help minimise the hassle of running a limited company and help make it a rewarding experience.
There are a few options you have to start your own limited company:
1. Companies House
You can register your company online yourself through Companies House for a very small fee. You will then need to go about setting up your business bank account and registering your company for National Insurance Contributions, PAYE and VAT (if required).
2. Formations service
There are services available online that can complete the formations process for you, and many formations providers offer packages ranging from a simple incorporation to a full-blown company setup. After that, it’s up to you to manage ongoing administration.
3. A specialist accountant
An accountant can help you complete the whole formation and set up of your limited company, and help you with ongoing administration. Using a specialist accountant is also beneficial in that they’ll know your industry better than a standard high-street accountant, and can help you legally reduce your tax bill.
If you plan to run your own limited company as a contractor or freelancer, look for a specialist accountant who knows the industry well. A specialist accountant can help you maximise your take home pay through careful tax planning whilst keeping your administrative burden to a minimum.
Our checklist can give you an idea of what to look for in an accountant so that you make an informed decision.
If you have any questions about what you’ve read here, give us a call on 01707 871622.