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!
