A Contractor's Limited Company
Summary of Key Points
- The legal distinction between a director and his or her company is a critical element in defending IR35.
- Above £35,000 of net profits, he or she will definitely be financially better off going limited even after accountancy and legal fees.
- There are other advantages other than tax savings in going limited.
- There are drawbacks other than higher accountancy and legal fees in going limited.
- There is administrative hassle in forming a company, and more in running one too.
Forming a limited company is a step to take after careful consideration of all the issues involved. The tax and NI situation is one of many factors to consider.
The legal form in which a business is conducted can make a big difference to its tax treatment and other legal issues. One of the main decisions a business faces in the early stages is whether to form a limited company to trade under. This paper considers whether a sole trader should form a limited company which is 100% owned by him or her and connected parties e.g. spouses.
In the eyes of the law, a limited company has just as much status as a real person. It can own things, borrow money, employ people, trade, sue people and so on. In many ways, setting up a company is the legal equivalent of having a baby. Just like having a baby, it’s not a step to take lightly.
There are often various steps between a limited company contractor and his or her ultimate customer:
Contractor - Contractor Limited Company - Agency - Ultimate Customer
The first of these is very important. Tribunals and courts are reluctant to set aside the legal distinction between a company and its owners, also known as the corporate veil. In addition, it is the contractor limited company which in English Law is the employer of the contractor, not the agency or ultimate customer. Without this crucial element HMRC would undoubtedly have generated much greater tax revenues from IR35.
The Advantages of Being Limited
- At present, there is often a substantial saving in National Insurance from being limited.
- The company can offer limited liability i.e. in the worst case it can go into liquidation without the shareholders being declared bankrupt.
- A limited company can be perceived in a better light, especially in certain industries such as the IT sector.
- Pension contributions can be made more tax-effectively within a company providing you’re paying yourself a big enough salary.
- The timing of dividend payments can be used to delay the tax payments on the profits of the business.
- If relatives are involved in the business administration this can save tax and NI.
The Drawbacks of Being Limited
- Creating a company is much easier and cheaper than killing one off. You need to be sure you want to trade in this form for at least the next three years.
- If you have any losses in the business, they won’t carry forward into the company. It’s usually better to use these up as a sole trader then go limited.
- There is a lot of additional administration. See Section 6 below.
- There will be additional accountancy and legal fees to pay – £400 or £500 per year for a typical sole trader with sales of £30,000 to £50,000 per year.
- Some of your financial information will now be published at Companies House.
- You must strictly keep your own finances and those of the company separate.
- You must be more careful over your choice of business name.
- UK law imposes some strict duties on directors and some stiff penalties for breaching them.
- If you are not the sole shareholder, a shareholders’ agreement at the time of forming the company is a good idea. This will spell out how shareholders can exit the company and what responsibilities they have, to avoid future misunderstandings.
- If you are going to pay yourself mainly in dividends, you must check with certain types of insurance – and mortgage providers – whether they will include this in their income assessments.
- Dividends count as investment income. They therefore do not count towards pensionable earnings. If building up a pension pot is important to you, you’ll need to take a bigger salary out and this will reduce the attraction of being limited.
- When you make a dividend payment, it is a legal requirement that you are making the payment from retained profits you have built up in the business.
- The tax on company cars is hefty, so it usually pays to run cars outside of the company.
What are the Financials?
When sole traders turn limited, they normally take £758 as basic salary through PAYE. The rest of the profits will then be taken as dividends on a monthly or quarterly basis. The NI threshold for 2023-24 is £9,100 so a salary of £758 per month ensures that the person gets an NI credit towards state pension and that they pay no employer’s NI. They can then take any remaining profits as dividends which are totally exempt from NI. However, dividends are taxed as follows:
- 0% for the first £1,000.
- 8.75% within basic rate tax band.
- 33.75% within higher rate band.
- 39.35% in the highest band.
It normally pays to be limited once £35,000 of profits before tax are expected in the year ahead.
The Administrative Hassle of Forming and Running a Company
When you form a company the following need to take place:
- Issue share capital and pay for it.
- Draw up Memorandum and Articles of Association – which specify how the company will operate internally, and how it will deal with the outside world.
- Decide on a registered office.
- Obtain the company number from Companies House.
- Set up records for the share register, directors and company loans.
From then on, running a limited company involves:
- Keeping the records up to date.
- Filing accounts on time every year with Companies House.
- Filing a Corporation Tax return every year on time.
- Making sure all company stationery complies with the Companies Act.
- Making sure that the necessary legal documents and calculations are draw up when dividends are paid.
Success Factors for “Going Limited”
You should find it no problem to run a limited company if you:
- Keep excellent records of your sales and expenses.
- Always file your VAT return accurately and on time.
- Always file your tax return well before 31 January.
- Have identified your board of directors and are confident there will be no changes in the next three years.
- Have identified your company shareholders and are confident there will be no changes in the next three years.
If you’re not ticking several of the above boxes, think long and hard about whether a limited company structure is right for you.