Limited Company Benefits
Hundreds of private limited companies are being formed every day. If you are thinking of starting a new business, or are currently in business as a sole trader or partnership, you really need to be thinking about whether to trade as a private limited company as there are many benefits.
Please note that we are not necessarily recommending or endorsing the use of private limited companies, but we feel that all business proprietors need to be aware of the potential benefits.
Private limited companies continue to be the chosen option for huge numbers of freelancers and businesses. Recent taxation changes have reduced the benefits of using a limited company compared with trading as an unincorporated sole trader, but in many cases, there remain compelling reasons to trade via a limited company.
Personal Asset Protection
As a sole trader or partnership, there is no legal distinction between “the business” and its proprietors. All proprietors are jointly liable for the business debts and liabilities. If the business cannot meet its debts and liabilities, the creditors, including banks and finance providers, taxation authorities, suppliers, employees, and anyone else with a valid claim, can sue the proprietors personally for their debts. There is therefore a real risk that a proprietor could lose some or all of their assets, including savings, investments and possibly their home, to pay the business’s creditors.
In contrast, in a private limited company situation, the company is a separate legal entity with its own assets and liabilities. As long as the proprietors act honestly and without negligence, their personal assets are normally safeguarded. The company’s creditors would normally only have a claim against the company, not against the proprietors, unless personal guarantees had been given by the proprietors.
In today’s “claim culture”, protection of personal assets is rapidly becoming an important consideration for anyone in business.
Potential Tax and National Insurance Savings
As a sole trader or partnership, you would pay tax at “personal” basic rate of 20% (and up to 40% for higher rate taxpayers) and national insurance of 10.25% on most of the “profits” made by the business, not on the amount you take as drawings. This makes a particular negative impact on businesses where profits are kept in the business to finance working capital or future growth.
By contrast, a small private limited company pays a lower rate of corporation tax on its profits (currently 19%), does not pay national insurance on profits made. So if profits are retained within the company to fund future plans, rather than being drawn out, the tax/nic savings can be quite substantial.
Careful planning of wage levels, dividends and profit retention normally results in lower overall tax liabilities, and facilitates long term tax planning strategies, such as spreading income over several years to avoid personal higher rate tax.
Red-Tape and Bureaucracy
The use of a limited company is more expensive and burdensome, but this is the price payable for lower taxes and greater protection.
In the 1980s/1990s, there were huge costs and burdens imposed on limited companies, which made them very unattractive for the average business. For decades prior to that, it was usual practice for most business to be limited companies. During the 1980s/1990s, most typical new business start ups would not have been limited companies, due to the costs and bureaucracy, not helped by higher tax rates for limited companies at that time.
Year by year, these burdens are being reduced and now the costs may be just a few hundred pounds per year, which compared with the potential benefits, make a limited company into a viable option for the average small business.
Surely the tax authorities won’t allow this..
It is the job of the tax authorities to apply the law, not to make “moral” judgements. Usage of a limited companies is perfectly normal business practice and is completely legal. The current tax and company law regimes encourage business proprietors to operate in this way. Governments over the past decade have had ample opportunity to change the laws, but have, generally, introduced more concessions and reduced administrative burdens as each year passes, clearly encouraging new businesses to operate as limited companies,.
If the company is not properly administered and the correct paperwork is not in place, then yes, the tax authorities can (and will) impose penal tax and national insurance. However, if the company, and its directors, have complied with Company Law and the relevant tax law, in that all the formal paperwork (including accounting records) is up to date, then the tax authorities have no grounds for challenging the legitimate and legal operation of your business.
Of course, there is no guarantee that the laws will not be changed in the future to remove some, or all, of the benefits.
Why doesn’t everyone do this?
A great number of businesses have transferred to limited company status and a high proportion of new start-ups are limited companies, but there are some cases where the business should be a sole trader or partnership:-
• Certain trades and professions are not allowed to operate through limited companies;
• Certain trades and professions (i.e. banks and insurance firms) require a formal “statutory audit” which can be expensive
• If profits are low, or losses are expected, there may be no tax savings or repayments, to set against the costs of the limited company.
• If you are required to give personal guarantees to the bank or other major suppliers, or if you don’t have any significant private assets, you may not benefit from the “personal asset protection” of a limited company.
A thorough review of your business and personal circumstances is essential before deciding whether to trade using a limited company.
So what’s the catch…
Trading as a limited company involves a lot more “responsibility” than the informal method of being a sole trader or partnership. Proper accounting and administrative record must be kept, certain rules imposed under Company Law must be followed and various documents must be filed at Companies House every year. Failure to follow the rules and procedures will result in you facing fines and penalties.
The benefits can only be achieved by proper planning and compliance with a complex set of rules under current Company Law and Tax Law.
If you are having trouble keeping up with accounting, tax and administrative responsibilities as a sole trader or partnership, you should certainly not even contemplate becoming a limited company unless you get professional help, and are willing to engage a book-keeper to keep the paperwork and formalities under proper control.
Typical Company Set Up
The proprietors must operate the business at “arm’s length”. There is a legal distinction between the company and its shareholders, so care must be taken to ensure that transactions are not confused. In particular, a limited company bank and credit card account are required – personal accounts should not be used for company transactions. Furthermore, there must be no doubt that customers and suppliers know they are dealing with a limited company so the company name and registration details should be clearly shown.
The shareholders own the company and receive dividends out of profits made. The directors manage the company and receive wages. In typical small companies, the shareholders are also the directors, so will receive dividends and wages. Shareholding proportions, dividends and wages are all flexible and can be “planned” to maximise potential benefits. Wages can be paid weekly or monthly, but dividends can only be paid out of profits made, and are usually less frequent – quarterly or annually.
Contact us for more information about limited company benefits.