Starting your own limited company
So you have made the decision to become self-employed and want to start trading? Generally you will have three options for which structure you want to work under: work as a sole trader, form a partnership with someone or set up a limited company. There are two types of limited company; a public limited company (plc), which you can buy and sell shares from on the stock exchange, and a private limited company (ltd), which are privately owned. This article will focus on the formation of a private limited company.
Why set up a limited company
Sole traders are self-employed individuals whom invoice their clients just as a limited company would, but minus all that dreaded paperwork. If this is the case, then why would people bother going through all the administrative hassle of setting up a limited company?! For a start, a limited company is a separate entity to that of the contractor. Its legal and financial responsibilities are completely separate, meaning that if the limited company found itself in financial difficulty, it would not affect the contractor at all. Their only risk is the capital they invest in the company. This is where the term limited liability comes in. Since it is a separate legal identity, it means it will also have separate borrowing power, meaning you have more access to funds to finance the business.
If you are a sole trader, there is no legal difference between yourself and your “company”, which will just be your trading name. If your company gets sued, it means that you are getting sued too. This could cause you serious financial problems, including getting your home repossessed or losing your car.
Tax Benefits of a limited company
Another major advantage of setting up a limited company is the tax benefits. A sole trader will pay Income Tax and National Insurance Contributions on any profits made on your business. As a limited company, you will pay Corporation Tax of 20% on the company’s profit, but no National Insurance. This profit figure will probably also be lower since you can claim more expenses as a limited company. You are legally allowed to claim money back for things like training, accounting services and even equipment and software. Therefore, the figure you will be taxed on will be lower in the first place.
A limited company is legally required to have at least one director, which is usually the contractor, who is also usually the owner. As the owner, they are most likely to be the only shareholder. Limited companies often only issue 1 share at the value of £1, in order to reduce their liability to the grand total of £1 if anything goes wrong. Companies will get more shares issued if they are doing well financially. As a company director, you are able to take much more control of your finances. A standard way of getting paid is to issue yourself a small salary and pay the rest to yourself in dividends. This is the more favourable method of payment as you do not need to pay National Insurance on dividends, thereby giving you less tax to pay again.
How to set up a limited company
When setting up a limited company, you have two options; the easy way or the hard way! The easy way is to get your accountant or a company formations company to do it for you. The prices can range from around £30 to £150 and you won’t need to worry about a thing. Now that Companies House accepts applications electronically, this may be a good way to go.
The hard way is to do everything yourself. You need to send in a memorandum of association, a completed IN01 form and articles of association to Companies House. Whilst their staff are extremely helpful and can guide you, the process is rather time consuming and they are not too accommodating if you make a mistake. I would recommend taking the easy route, rather than trying to save a few pounds. Most contractor accountants will ensure that you have all the right documentation and even provide you with advice.
In order to register though, you need to have a UK address, which you can use as the registered business address and know who your company officers are going to be. Company formation companies often offer registered business addresses “to rent”. When using one of their addresses, you will get your mail forwarded to your home address, so that you don’t need to give out any personal information. It also gives off the impression that your company is really official if it looks like it is trading at a fancy address.
Precautions to take before setting up a limited company
There are a few things to be aware of before you go ahead and set up a limited company. As a sole trader, since there is no difference between the legal or financial status of the individual and company, they can just take money out of their bank account whenever they want without anyone saying a word. When running a limited company, there are only three ways you are legally allowed to extract money from a company account:
1) When paying a salary
2) When paying dividends
3) Repaying expenses
You must also make sure that there is enough profit in the company before paying yourself dividends. If you pay yourself more money than the company owes you, you could end up with some serious tax issues!
There is also zero privacy when it comes to running a company; your company details are all public record. A quick search online and it will display your company’s registered address. As a company director, you are legally obliged to submit accounts to Companies House each year. These can also be accessed by anyone, although they may need to pay a small (very small, around £2.50 in fact!) fee in order to do so.
If the legal obligations of the director are not met, they could be subject to some serious penalties. There are hefty monetary fines, possible disqualification of ever being a company director again and even imprisonment! Setting up a limited company is a big decision and is not one to be taken lightly!