A question that we’re regularly asked is about becoming a limited company. You may be an established sole trader that is looking to move to limited company status or you’re setting up a new business and want to decide the best structure from the outset. Here, we look at the main considerations for anyone thinking of setting up a limited company.
What is a limited company?
A company is a legal entity with a separate identity from those who own or run it. Please note that a business cannot operate as a limited company until it has been incorporated at Companies House. Incorporation is the process by which a new or existing business registers as a limited company.
What types of limited company are there?
Broadly, there are two types of limited company, those that are ‘limited by shares’ or those that are ‘limited by guarantee’.
Limited by shares
Limited by shares companies are usually businesses that make a profit. This means the company:
- is legally separate from the people who run it
- has separate finances from your personal ones
- has shares and shareholders
- can keep any profits it makes after paying tax
Limited by guarantee
Companies that are limited by guarantee are usually ‘not for profit’. With this structure, the company:
- is legally separate from the people who run it
- has separate finances from your personal ones
- has guarantors and a ‘guaranteed amount’
- invests profits it makes back into the company
What are the benefits of being a limited company?
Dependent on your particularly situation, there can be a number of benefits to setting up as a limited company. These are the main advantages:
There’s limited liability protection
The ‘limited’ element in limited company refers to the fact that the shareholders of the company have limited liability protection. This means that the amount they would lose if the company failed is strictly limited unless there’s fraud or other serious wrongdoing. For example, if the company were sued, your personal possessions couldn’t be seized to pay the debt (unless you’d given a personal guarantee to a company creditor).
You might pay less tax
- Limited companies don’t have to make payments on account as sole traders do
- Corporation tax on profits is currently payable at a lower rate than the income tax paid by sole traders
- Limited companies don’t need to pay national insurance
However, it’s worth bearing in mind that limited companies are not entitled to a personal allowance and the difference in tax savings is not always significant. Please take expert advice in this area to determine what your tax position would be.
You might be able to claim more tax relief on expenses
As a limited company, you’re entitled to more tax relief on some expenditure. For example, a limited relevant food and drink expenses can count as business costs. Sole traders can only claim this kind of tax relief only in very specific situations.
It may be easier to attract new customers or secure investment
In certain sectors or under specific circumstances, having limited company status may work in your favour or indeed, be a requirement when bidding for new business.
Likewise if you’re want to secure investment in your business, as a limited company, you’d be able to sell shares in your business to encourage an interested party.
What are the disadvantages of being a limited company?
There’ll be more financial administration
A sole trader only needs to file a Self Assessment tax return once a year, but limited companies have other filing requirements:
- a set of accounts
- a confirmation statement (previously called an annual return)
- a corporation tax return
In addition, each company director usually needs to file their own self-assessment tax return. If you are set up as an employee of your company and take a salary, you’ll also need to register the company as an employer, and then set up and run payroll.
Taxation rules are stricter
Directors of limited companies cannot draw money freely out of the business bank account. When a limited company makes a loss, it can only use that loss against its own profits.
Directors of limited companies have certain legal obligations
As well as safeguarding the company’s assets, it would fall on you to make the decision to cease trading if you knew the company couldn’t survive. If you failed to meet any of these responsibilities, you could be fined or even go to prison.
Some of your information will be made public
As a legal requirement, parts of a limited company’s accounts are published on the Companies House website. This would mean that your financial information and your company’s registered address will be available for anyone to view.
Is a limited company right for you?
Deciding whether to incorporate your business is very much dependent on your own circumstances and there may be other factors than those outlined here that need to be considered. Please get in touch if you have any questions or, if you’d like more in-depth advice, we can set up a meeting to review what would work best for you.
Further information
The government’s guidance ‘Set up a limited company – step by step’ gives a comprehensive overview of how to go about setting up a limited company.
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