Limited Company Explained
Unlike working as a sole trader, a limited company is a legal entity in its own right. It has a different structure and different requirements in relation to tax .
The biggest different between a sole trader and a limited company is that a limited company has special status in the eyes of the law. Limited company’s are incorporated – registered with Companies House – and it issues shares to its shareholders.
It operates as a distinct legal entity to its directors and shareholders – the company is an ‘individual’ in its own right. This means that all the business assets, liabilities and profits belong to the company itself and the shareholders are not wholly responsible for debts incurred by the company.
A director of a private limited company is considered an employee of the company. This means if the company fails, a director’s personal assets such as family home or savings are not at risk – unlike a sole trader. The shareholder’s liability is limited to the shares they hold in the business – hence the ‘limited’ part of the business structure name.
Who can set up a limited company?
The owners of private limited companies are known as shareholders and each holds a certain number of shares in the business. To become a shareholder you must purchase one or more shares issued by the company on formation.
What are the advantages of a limited company?
- Limited liability – as company owners are not legally obliged to pay outstanding company debts beyond the value of the shares they hold it protects the personal assets (such as a home or savings) of the company owners should a business fail.
- Professional status – a limited company is typically seen as a more professional operation than an unincorporated sole trader. Other companies are more likely to trust limited companies.
- Tax efficient income – a limited company can be a tax efficient way to pay yourself, within legal limitations. Directors and company owners can pay themselves via a PAYE salary and then top this up with shareholder dividends after paying corporation tax. As corporation tax has been paid on profits any dividends paid are not subject to NICs.
- Protect your business name – when you incorporate your company its name is protected and other businesses cannot use the name or one that is similar when trading.
What are the disadvantages of a limited company?
- Legal requirements – there are more requirements such as completing annual accounts and returns to Companies House, delivering a corporation tax return to HMRC, setting up and running PAYE and payroll, and producing quarterly VAT returns for HMRC.
- Getting paid - As an owner or director the business has to legally transfer money to you in the form of a salary or dividend payment which means you can’t just use the company as a personal income source. You will need to register for PAYE with HMRC even to pay yourself as a director and run a monthly payroll to draw a salary.
- Setting up and closure – setting up a limited company is straightforward but you’ll need to register with Companies House and inform HMRC as well as pay annual fees. If you decide to close a limited company you’ll have to apply to dissolve the business which can take three months.
Tax, profit and loss for a private limited company
A private limited company must register with HMRC and pay corporation tax on any profits it makes within its financial year – and corporation tax is in addition to any income tax and National Insurance contributions (NICs) employees and directors must pay. A limited company can also pay dividends to shareholders and these are subject to income tax, though exempt from NICs. Payments to employees have to be made via PAYE and the company must as pay NICs to HMRC as part of an employee’s salary.
Employee salaries are classified as a business expense however and can be offset against profits along with all other expenses. This means that a limited company can pay staff, incur costs and purchase services from suppliers and still claim these as expenses to offset tax payable on the income the company generates. The company’s profit is then subject to corporation tax at the current rate of 19%.