‘Why should I become a limited company?’ or ‘Should I become a Limited Company?’
We are asked these questions on a daily basis. Right now if you were to google this, or ask friends and family you would be bombarded with opinions(!)
Here we try to break down what it means to ‘go Limited’.
Let us start by saying, we have limited company clients from very small cake makers to multi-million pound businesses. Whether being a limited company is right for you is often very specific to your circumstances.
We often meet new clients who have formed their limited company because they heard about the benefits. However struggled with the extra returns, accounts and other costly compliance activities that are required.
So, let’s look at the good and the bad:
A Limited Company is a separate legal entity. Owners a receive good amount of legal protection for their personal assets (such as their house) in the event of something going wrong.
This isn’t perfect, as often in finance situations directors or owners could be asked to sign personal guarantees to assign liability of debt repayment against them. however as a general point this protection is very comforting for a budding entrepreneur.
If you are taking on staff or going VAT registered this protection becomes even more desirable.
This is the one we get excited about most.
Simply put, the tax laws for Limited Company are different to that of a sole trader,
You can pay yourself via a mixture of both salary (think: payslips) and profits from the business (dividends), and you will save tax.
Many of these savings are achieved by paying not a lot (if any) of National Insurance and paying lower dividend taxes.
You can also still gain credit for your pension and benefits record while physically paying no National Insurance.
The rate at which the company pays tax on its profit is also less than that of an individual.
If you have another job limited companies are attractive because their profits are tax initially away from you as an individual, which means if you are paying higher rate tax (40%) your company can still pay corporation tax (currently 19%) and you won’t pay more unless you pay yourself money from the company. This can be a great benefit where you are re investing all of your profits.
There are also rules for expenditure such a ‘trivial benefits’ and ‘annual functions’ (think ‘xmas do’), which can provide tax savings not possible as sole trader.
As a sole trader doing well, you will pay large chunks of tax twice a year. A small company only pays once a year and although it is likely you will still pay some personal tax that could be twice a year, these payments will be significantly less than what you would pay as a sole trader, helping your cash flow.
Often limited companies have the feeling of being a more professional/established/’bigger outfit’. This is desirable for many business owners.
Investment made easy
Limited companies are ‘cleaner’ to invest in if you are taking on investment or partners. You can offer slices of your business ownership by splitting up the shares.
Limited companies cost more to run in accountancy fees. The main reason for this higher cost is the amount of paperwork and returns required to be compliant. It’s not really possible to completely do it yourself due to the need to meet the various legal accounting requirements, and having software that can actually submit the accounts and returns in a specific electronic format. HM Revenue & Customs do not supply a free tool like they do with a Self Assessment Tax Return completed by sole traders.
As a rough figure, it is unlikely you will spend less than £1000 a year on just the basic accountancy required for a limited company.
More detailed book-keeping required
You need to be able to know at a given date exactly what assets, liabilities & capital a company has. These are items such as what is owed to you as director/shareholder, what customers owe money and which suppliers are owed payments.
As a simple sole trader you are only really concerned with working out your taxable profit for your tax return; as a company you need this extra level of detail. You can argue that you need this information as a sole trader anyway, but the difference as a sole trader is all of the money is yours. With a limited company, as the money is the company’s, dates of when money is drawn out or put in are very important and getting this wrong can cost tax (or getting it right saves it!).
As a result you either need to gain these book-keeping skills or outsource them. There is also a software cost in the mix. Despite some common misconceptions, book-keeping is a technical profession and not just a case of keeping your paperwork tidy…
The bottom line
So, what’s the answer then?
Well, as we’ve mentioned, it is specific to your situation, but the most common situation (at the time of writing) we see is where a sole trader is making in excess of £25,000 per year PROFIT. At that level, you are in the zone where the tax saved is more than the extra costs of having a limited company.
This profit level can be lower depending on your situation. For example, if you are looking to reinvest the profits and have another job, this level can be a lot lower and still be worth being limited over sole trader from a pure tax point of view.
If you have any specific questions on your situation, please don’t hesitate to give our team a call – we’d love to chat to you.