There are three business structures in the UK and a limited company is one of those.
A limited company will allow an individual to create a business. The only capital that will be at risk is the investment and not the personal finances of the owner and so provides a degree of security.
As you can imagine, this business structure is a popular way to start a business as it provides protection. After all, 20% of small companies fail in the first year, 30% in the second and 50% in the first five years so having your personal income protected is a huge advantage!
Should the business have any debts, these are to be paid by the business and not the owner. This is different from a sole trader as in the eyes of the law, they are seen as a single legal entity. The business owner's personal finances are taken into account when it comes to paying the business's debt.
The biggest difference between a limited company and a sole trader is liability.
A sole trader will have full liability for the business, this includes debts, losses and legal claims.
Whereas the owner of a limited company doesn't face any of that, they have limited liability. The company formation is seen to be separate from the owner and this comes with many advantages and disadvantages.
These advantages can help to reduce some financial stress and strain, leaving with you a greater return when it comes to tax return time.
What has to be the biggest upshot of forming your own company is the protection that it provides.
If you end up in the unfortunate position that your company is in trouble, then your personal finances and assets are treated as a separate entity and are therefore safe.
In a separation known as the "corporate veil", a limited company is treated as a legal 'person' and is treated independently of the people who own it.
This means that should the company have any debts, legal claims or losses, the company is responsible, not the owners.
The owner of the company will be a shareholder and so if the company falls into difficulties then the owner would only need to pay the creditors the nominal value of unpaid shares. Any personal assets the owner has will be protected.
While the process of setting up as a sole trader is easier as the business is not registered with Companies House officially, it does leave you with fewer rights.
Unless you were to get your business' name trademarked, then anybody is free to use the name and you have no recourse.
However, (and this is where a limited company has the edge) when your business is registered with Companies House, your business name is trademarked, meaning nobody can use it.
If you think how increasingly important it is to have a unique name in business and to be able to be found easily online, you begin to realise why this is a key factor when deciding to create a limited company.
Aside from that, Limited companies do come across as bigger than they actually are, this is usually good for the image of the business as they can appear to be more professional.
It can even impact the likelihood of attracting clients and investors, sometimes it can go as far as making the difference between getting a bank loan or not - simply because they look more secure.
We all know we have to pay tax and we all do so, reluctantly in some cases but creating a limited company means a tax return of maximum 25% Corporation Tax on profits.
This may still seem like a lot but sole traders pay 20 - 45% income tax on their profits so there are potentially big savings to be had.
It also means that rather than withdrawing all of the profits every year and paying more personal tax on top of the Corporation Tax liability, you are able to keep the surplus income in the business, allowing you to pay for any future costs and growth.
This is a much better option than withdrawing all of the profits and paying greater rates of income tax to then put (already taxed and therefore less) money back into the business when needed.
Creating a limited company is a way to allow you to reduce your Income Tax and National Insurance Contributions (NIC) as you can take a combination of a salary and dividends.
Having a business as a limited company means that if you keep your company director's salary below the NIC lower profits limit, there won't be any Income Tax or Class 1 National Insurance to pay with these earnings.
Equally, Corporation Tax will need not be paid on the salary by the company where the wages are considered to be a business expense.
The remainder of your income can come in the shape of dividends. The dividends come from post-Corporation Tax profits.
A real highlight is the Dividend Allowance, what this gives you is an annual allowance of £1,000. This means that you will not have to pay any personal tax on your first £1,000 of dividend income. Once you go above that you will be liable to pay Dividend Tax rates, though they are a lot lower than Income Tax rates.
These personal tax allowances can save you thousands of pounds worth of tax every year. This is one of the really big advantages of a limited company as opposed to sole traders.
As we have already discovered, limited companies are considered to be a legal 'person' in their own right, this is unlike sole traders. The identity of the directors and shareholders is a completely separate legal entity in itself.
This means that a limited company is able to enter into a contract in their own name, taking on debts against the companies name, not the directors.
Limited company = limited liability and this is true for owners also.
The owner of a limited company will find that they aren't liable for everything relating to the company. They are only liable for their unpaid shares and personal guarantees.
So if the unfortunate were to happen and the company ended up being insolvent then the directors and shareholders would not be declared bankrupt, even if the company was. Obviously given the personal repercussions of being declared bankrupt, this can literally make a huge difference to the future.
Some people understandably want flexibility with business ownership, life can throw a lot of things at us so flexibility is always good to have. With a limited company, you can sell or transfer ownership with little disruption to employees or clients. So if you don't intend to hang onto your business forever, creating a limited company can be the perfect option for you!
We have touched upon a limited company that can provide a status that a sole trader does not get. However, it can go further than that, certain businesses will only work with other incorporated businesses - this is very much the case in the IT field, finance, and construction. So if you see yourself working for or with these fields, you may want to seriously consider a limited company!
The reason for this style of working is due to the degree of risk that goes with the contracts that they award. If the risk is high, for example dealing with highly sensitive information or high-scale contracts then it is likely that your clients will require limited liability protection.
It is unlikely a sole trader will even be considered for these types of contracts.
A limited company is not restricted to one owner like a sole trader is. This means that should there be a need to raise any capital, shares can be sold to investors to make this happen.
As a general rule, companies do have greater opportunities when it comes to lending than sole traders.
Risking your own property can seem risky and not a very attractive option, with a limited company, there is no need for directors or shareholders to secure their personal property against the loan. This will provide peace of mind to many, I'm sure!
Do you want your business to stand out? To have its own identity? Perhaps those are silly questions, who doesn't!
A company name should really be unique.
Registering your business with Companies House provides that security that nobody else can use your company name, or even one that is similar.
A sole trader does not get this luxury.
People need to think about pensions, increasingly so. Company directors of limited companies can invest a pre-tax sum into a company pension scheme.
So if you're running a limited company, you don't need to remove money from the business to place into a personal pension - this will face business and personal tax. Set yourself up with a company pension scheme and reap the rewards!
Limited companies have shares, these can be issued to a family member, including your spouse.
You might be wondering why you would do this, well...it will allow you to split the profits and your personal tax liabilities will be minimised.
If you issue dividends to your children or spouse, you are able to take advantage of their tax-free Personal Allowance, basic tax rate and the Dividend Allowance of £1,000.
If you are the sole provider and/or you often provide financial support to your children then this is ideal.
As with anything, there are always some downsides. So what are the disadvantages of a limited company?
One of the disadvantages of a limited company is that you must register with Companies House. This process can be a little complex and does come with a fee.
“To reduce the stress of this process there are companies out there that specialise in limited company formation. Using these companies can ease the pressure off you for what can be a rather time-consuming task - spend your time doing more constructive things!
As we know, a limited company must go through Companies House in the UK.
What this means is that any information you provide; company annual accounts, records and details of directors and any shareholders is a matter of public record. Meaning that it can be viewed by anyone.
The level of privacy of a limited company is reduced. However, sole traders aren't faced with this issue.
Due to the additional paperwork needed for a limited company, you may find it easier to hire an accountant to manage your tax and tax returns. Naturally, this will come as an additional expense to the company. However, there are plenty of tax benefits that should mean this cost is offset!
It is almost unavoidable that things change in people's lives. When this impacts a limited company (a director resigns for example), Companies House must be informed immediately.
A limited company is likely to have a number of shareholders. Every shareholder is entitled to have a say in how the company operates.
The greater number of shareholders, the less ownership you have but also, the less say you have in the company. Some decisions you may not always agree with and you may enter into contracts you don't want to when you're running a limited company.
Starting a new business as a sole trader is a simple thing to do. There is no need to register with Companies House so this will save you a lot of time and some money!
However, there is no difference between the business and the sole trader in the eyes of law. So you could find your personal income at risk if your business was unable to meet financial obligations.
There is a benefit to this though if you want to remove money from the business for personal use, there aren't any complex steps you need to take.
Equally, if you want to keep your company affairs private, then doing business this way will keep them out of public eyes as accounts and other details aren't published online.
Tax returns are a necessary evil (and they aren't that bad!). Sole traders and any company directors who received remuneration other than salary through PAYE, must register for Self Assessment..
While tax returns can seem like a daunting thing, registering can be done within minutes on the HMRC website. Just pop in the following details and consider yourself registered!
Once you have registered you will receive a letter from HMRC. You will be given a Unique Taxpayer Reference (UTR), along with information surrounding your tax responsibilities and filing obligations.
A company formation will absolutely provide you with limited liability if your company was to end up in financial trouble.
Limited companies also get the advantage of better tax benefits, including corporation tax.
Let's not forget that a limited company also comes with a status that a sole trader does not. This in itself can generate business and allow you to enter into contracts you wouldn't be able to as a sole trader.
It's not all positive and there are some disadvantages of a limited company. Registering with Companies House takes time that a small business may not have. As well as the need to pay for the privilege of doing so.
Accounting and managing a bank account for a limited company will be more complex than that of a sole trader.
Setting up as a sole trader is free and the day to day administration is minimal, this can be a key factor for business owners and is a point worth considering. Time is money after all.
In terms of business structure, a sole trader is perfect for freelancers or a small business as the tax implications shouldn't have such an impact at this stage.
There are many advantages and disadvantages to both creating a limited company and operating as sole traders.
Which one is most suited to your business and business structure will depend on your needs and personal preference.
Spend time considering your business plans and long term goals. If you need to raise capital then you may find companies more willing to do so if your business is operating as a limited company.
There are unquestionably better tax benefits to a limited company.
Limited liability can be the perfect solution for your company. If you're still unclear which way to take your business, speak to an accountant or a business consultant and they will be able to point you in the right direction!
Get the best advice on tax savings, accounting services, payroll, self assessment, VAT and more, whether you want to call us directly, request a call back or chat online with our experts, rest assured that we will always give you the best advice.If you have any questions, or would like to speak to us in person, please do get in touch. We're here to help.
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