Limited Company or Not?

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February 16, 2022

We often get start-up businesses coming to see us, and one big question we often get is “should I be a Limited Company or not?

There used to be quite a tax saving from having a Limited Company and this far outweighed the slightly higher fees to operate versus a sole trader or partnership.

Sadly, for a business that needs to draw the profits out to pay its owners, the savings are not that great anymore.

So what’s the score now?

Companies pay Corporation Tax at a rate of 19%, no matter how high their profits are.

If they distribute the profits [after corporation tax] to the shareholder, this is done as a dividend and further tax is paid on this as follows:

  • 0% on the first £2,000 of Dividends in a year
  • 7.5% if the shareholder is a basic rate taxpayer
  • 32.5% if the shareholder is a higher rate taxpayer
  • and 38.1% if the shareholder is and additional rate taxpayer

Compared to self-employment where tax is paid:

  • 0% on the first £12,500 of profit
  • 20% up to £50,000 of profit
  • 40% on profits £50,000 to £150,000
  • 45% on profits over £150,000.

Profits for the self-employed and partnerships are taxed on profits regardless of whether the business can afford to pay the profits to the owners. On the other hand, Companies profits are taxed at a much lower rate and the extra dividend tax is paid only if the funds are paid to the owner.

What’s the answer then?

A Limited Company can be a benefit when there is an intention to reinvest profits in the business or retained funds for other reasons [in times of high growth where working capital is under pressure].

If the owners of a Company are looking to withdraw their funds to invest or save then it makes more sense to leave the funds in the Company and invest as a Company.

What happens when I need the funds?

When the business ceases or is sold, subject to certain conditions, this is treated as a capital transaction and the shareholders are taxed under the capital gains tax regime. This can mean a tax rate of 10% or in the worst case 20%. Much lower than the 32.5% or 38.1%!

Not the whole story though

There is one major other advantage to a Limited Company and that is in its name ‘Limited’. In the event of the business failing, the shareholders liabilities are limited to the assets of the Company, creditors cannot [except in rare circumstances!] go after the shareholders personal assets.

This might sound like a remote risk but it’s not just going bust for trading reasons. There might be an uninsured loss or claim that brings down a business – normally the shareholders would be safe from being caught up.

Yes or No?

Taking everything into account we still think a Limited Company works for all but the smallest business start ups! If anything here is unclear, or you need to discuss special cases, please get in touch with us here!

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