The question of whether to run a business as a limited company is a major decision. Here we look at some of the key areas to consider.
Income tax vs corporation tax
For limited companies, it is the company and not the director-shareholder that pays tax. The current rate for corporation tax is 19%, meaning that the tax due on profits made within a company will be less than the income tax paid by a sole trader or partner with the same profit figure. However, the profits of a company may be subject to income tax and national insurance contributions (NICs) when they are extracted by the director-shareholder.
Many director-shareholders take a basic salary from the company, and extract profits by way of dividends. If they receive any form of cash remuneration, these are taxed as employment income. Such income is liable to income tax in the normal way.
Director-shareholder salary is tax deductible for corporation tax purposes. Uneven patterns of earnings, which could mean a spike in a tax bill for a sole trader, can be evened out by adjusting director remuneration.
National insurance contributions
Employment income attracts Class 1 NICs, for which both the director-shareholder and the company may be liable. Though employees are not liable to NICs on most benefits, Class 1A is generally due from the employer at 13.8%.
Director-shareholders have considerable flexibility when it comes to NICs. It may be possible to take a small salary of up to the threshold at which NICs are payable (£8,424 in 2018/19), and take the balance of post-tax profits as dividends. Earnings above the Lower Earnings Limit (£6,032 in 2018/19) are deemed subject to NICs at 0%, so paying a salary above this level will accrue entitlement to certain state benefits, even though no NICs are actually paid.
Dividends have their own distinct tax treatment and are not liable to NICs. When combined with the Dividend Allowance, which taxes the first £2,000 of dividends at 0% (for 2018/19), dividends can produce a favourable outcome for the taxpayer. But remember that dividends are paid out of taxed profits, meaning that corporation tax also needs to be factored in.
A company may be able to make contributions into a registered pension scheme, subject to certain limits. Appropriate care is needed, and pension contributions must be paid ‘wholly and exclusively’ for the purposes of the trade in order to be deductible. For sole traders and partners, pension contributions would be considered a private expense.
Leaving profits in the company
Where director-shareholders do not need to extract all the profits from the company to meet current expenditure, profits can be left in the company, opening up further future planning possibilities.
Additional benefits of incorporation
Some other benefits of incorporation might include obtaining limited liability, as well as additional credibility. A company is a separate legal entity from its shareholders. It can own property, sue and be sued. In terms of borrowing, limited company status can allow a bank to take additional security by means of a ‘floating charge’ over the assets of the company.
Incorporation brings additional administrative responsibilities, which can lead to higher annual compliance costs. Company directors also have certain statutory responsibilities, and as such, they may be at risk of criminal or civil penalty proceedings for non-compliance. Business owners should consider the legal and administrative implications, together with their associated costs, before making any decisions.
We can advise on all aspects of running a limited company – contact us for assistance.