For some business owners, the decision to incorporate their companies can deliver real financial benefits.
A few years ago, the personal and corporate tax advantages offered by changing from a sole trader status to a limited company structure were the main driver behind the rush to incorporate. Those benefits have been greatly reduced over the years so is it still worth it for today’s business owner?
In this article, the TFMC team look at the different types of incorporated companies and how the way incorporated companies distribute money could save you £1,000s each year.
What does incorporating your business mean?
An incorporated business has its own distinct legal identity. It exists separately from its owners and employees. A corporation can buy and sell property, be taxed, and even commit crimes in its own right. Both new and existing businesses can register to become a limited company.
There are four types of incorporated company:
Private company limited by shares
A private company limited by shares is owned by its shareholders and each shareholder has personal liability up to the amount that’s “unpaid” on their shares. A private company limited by shares can offer its shares for sale to other individuals and companies but it cannot do so on a listed stock exchange.
Private company limited by guarantee
A private company limited by guarantee has no shares or shareholders – its members/owners are known as “guarantors”. Each guarantor’s financial liability is capped to the amount they agree to contribute to the assets of the private company limited by guarantee if it subsequently declared bankruptcy.
Private unlimited company
An unlimited company may or may not have a share capital but there is no limit to the members’ liability.
Public limited company
A public limited company has a share capital and limits the liability of each member to the amount unpaid on their shares. It may offer its shares for sale to the general public and may be on a stock exchange.
What are the benefits of incorporating your business?
The biggest advantage of incorporating your business is the potential for a significant reduction in your tax bills. Profits that a company makes are subject to corporation tax (which is currently at 19%) as opposed to the up to 45% income tax you pay as a sole trader and associated National Insurance.
You can then take these profits (after tax) and pay yourself them in the form of dividends. Dividends are taxed is a similar way to income tax however the rates are significantly lower and you have an additional £2,000 annual allowance you can take advantage of.
You can also leave money in your company. Think of it this way – “my money” and “company money”. As a sole trader, you might make £100,000 a year in profit on which you pay tax on the entire amount because “my money” and “company money” are one and the same thing. If you’re a limited company, you’ll pay corporation tax on your profit and once that is paid, you can pay yourself some of it (“my money”) and leave the rest in the business (“company money”).
Let’s look at an example. Let’s say that your limited company made £100,000 profit from which you paid yourself your £11,850 personal allowance. You’d pay £411.12 in Employee’s NI, £472.79 in Employers’ NI, and corporation tax of £16,658.67. After all of this had been paid out, there would be £71,018.54 left.
You could then pay yourself £34,650 in dividends on which you’d pay dividend tax of 7.5% on £32,650 (there is an annual £2,000 dividend allowance). That’s “my money”. Subtract your £34,650 in dividends from the £71,018.54 that was left and £36,368.54 would remain – that’s “company money”.
As a sole trader, you’d pay the prevailing rates of tax and National Insurance on the entire £100,000 minus your personal allowance because there is no difference between “my money” and “company money”. You’d pay £28,360 in income tax, £4,486.34 in National Insurance Class 4s, and £153.40 in National Insurance Class 2s.
Using this scenario, as a sole trader, you’d pay a total of £32,999.74 in tax. As a director of a limited company, you’d receive a total of £46,500 on which you’d pay £2,448.75 in dividend tax, leaving you with £44,051.25 and your company would still have £36,358.54 in the bank.
You also have “Limited Liability”. Because the company is a separate legal entity to yourself, you will not be personally liable for any financial losses that your business makes. If you are self-employed and operate as a sole trader, all company debts are also your personal debts.
TFMC top tip – caveat emptor with limited liability. Many commercial finance companies, suppliers, and even landlords will insist that you sign a personal liability agreement with them making you fully responsible for any debts your company incurs and which it cannot pay off.
If you’re looking for investment into your company or to take out a business loan, a limited company structure is far more desirable to work with than a sole trader or partnership.
How to incorporate your business
It is a simple process to set up a limited company. The most common way to do it is online.
You will need to register your business with Companies House. To do this, you will need a suitable company name, the address that your company will be located at, the details of at least one director, and details of how the company’s shareholding structure (you will need at least one shareholder, however, this can be yourself).
You will also need to give the details of anyone who has “significant control” over your business. This is anyone who owns more than 25% of the shares.
Once you have all of this information to hand, you can visit this government page. They claim that your company will be set up within 24 hours.
The costs of setting up a limited company can also be offset against your profits in order to reduce your corporation tax.
We can help
If you would like advice on how to set up your own limited company, or even if you are unsure about whether or not it is right for you and your business, get in touch with our team on 0800 470 4820 or email [email protected].