Key benefits of a limited company: A balanced overview
What are the real advantages of incorporating as a limited company? From protecting your personal assets to benefiting from favourable tax conditions, the benefits of a limited company offer numerous perks for savvy entrepreneurs. This guide details the definitive benefits that differentiate a limited company, setting your business up for potential growth and success.
Overview:
- Understanding limited companies
- Financial advantages of a limited company
- Legal and financial shields
- Professional image and credibility
- Access to funding and growth opportunities
- Streamlined administration through Companies House
- Tailored tax planning and benefits
- Navigating disadvantages with professional advice
Understanding limited companies
What is a limited company? And why should you consider it as the structure for your business? A limited company is a business structure where the company is a legally distinct body from the individuals who run it. This legal concept of ‘separate legal personality’ provides a shield for personal assets against company liabilities.
There are two types of limited companies: private limited companies, which cannot offer shares to the general public, and public limited companies (PLCs), which can. The shareholders of a limited company have limited liability, meaning they are not personally liable for the company’s losses or debts beyond their initial investment.
To set up a limited company, one must register with Companies House in a process known as incorporation, which includes providing details such as the business name, address, directors, shareholder details, and capital information.
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Financial advantages of a limited company
One of the compelling reasons for setting up a limited company is the financial advantages it offers. For starters, limited companies benefit from a Corporation Tax rate of 19% to 25% on profits, whereas sole traders may be taxed at personal income tax rates between 20% and 45%. This lower tax rate is one of the significant tax benefits that boost the financial health of your company.
Apart from the attractive tax rates, directors can optimise tax efficiency through a combination of a salary just below the National Insurance threshold and dividend payments. This strategy minimises National Insurance Contributions while drawing an income. Moreover, directors of limited companies can invest pre-tax sums into company pension schemes, effectively reducing the amount of overall corporate tax due and the need to pay Income Tax.
Pay less Corporation Tax
Delving deeper into the advantages of lower Corporation Tax, let’s consider a comparison with the personal Income Tax rates for sole traders. Limited companies in the UK benefit from lower Corporation Tax rates of 19-25% on profits compared to 20-45% Income Tax rates for sole traders, allowing for more efficient tax planning.
Dividends, which are paid from profits after the deduction of Corporation Tax, are taxed at a rate of 19% for profits up to £50,000 and 25% for profits over £250,000, with marginal relief for profits between £50,000 and £250,000.
This offers flexibility in deferring profits to a later tax year to benefit from lower business or personal tax rates, which is advantageous if withdrawing profits would push a director into a higher tax bracket. To pay Corporation Tax efficiently, it’s essential to plan and manage the distribution of dividends.
Optimising directors’ remuneration
Beyond the benefits of lower Corporation Tax, optimising a director’s remuneration is another strategy to maximise the financial advantages of a limited company. Directors can optimise their take-home pay by adopting a remuneration strategy that involves drawing a minimal salary while supplementing it with higher dividends.
Dividends provide a tax-efficient form of remuneration for directors, as they are taxed at a lower rate compared to Income Tax rates and do not incur any tax through the company.
Moreover, a director’s salary and the corresponding National Insurance Contributions are deductible as business expenses, which can reduce the company’s Corporation Tax liability.
Pension contributions are also highly tax-efficient for directors, being fully deductible as company expenses up to an annual limit, allowing investment of pre-tax trading income rather than personal income after tax.
Deductible business expenses
Similarly to sole traders, operating a limited company opens the door to the opportunity to claim various business expenses. Essential equipment like computers, software, and office furniture necessary for business operations can be claimed as expenses.
Not just that, costs for the use of a home as an office, such as a portion of household costs and utility bills, can be claimed based on the proportion of the home used for business purposes.
Professional development and training course fees are claimable expenses when they enhance the director’s professional skills with the business. Even travel costs necessary for business are deductible, such as mileage, public transport fares, parking, tolls, accommodation during business trips. The ability to claim such a variety of expenses reduces taxable profit and enhances tax efficiency.
A key difference between sole traders and limited companies when it comes to business expenses is that, for limited companies, salaries and employer’s NICs count as business expenses, further reducing Corporation Tax, whereas sole traders pay Income Tax on all their income.
Legal and financial shields: The limited liability advantage
Operating a limited company offers more than financial benefits; it also provides a legal and financial shield for your assets.
The concept of limited liability defines a clear separation between the business and its owners or managers, relieving them from legal obligations beyond the nominal value of their shares. This separation establishes the business as a separate legal entity, further protecting the personal assets of its stakeholders and granting it a separate legal identity.
Protection of personal property
The fundamental principle of limited liability is the protection it offers to personal property. Limited companies provide a level of protection for personal property, as the company’s financial liabilities and legal issues do not typically extend to the personal assets of its shareholders or directors.
This means that the structure of a limited company separates personal assets from the business’s liabilities, ensuring they are not automatically used to settle business debts. Shareholders of a limited company are protected from creditors seeking to claim personal assets to satisfy company debts, as their liability is restricted to their investment in shares.
Safeguard against personal guarantees
Limited liability does more than just protect personal property; it also safeguards against personal guarantees. Directors are typically not held personally responsible for a limited company’s debts, unless personal guarantees are signed or in cases of wrongful trading.
While challenging, personal guarantees can be minimised or avoided in certain business contracts, and their scope can be specifically limited based on business performance and defined conditions. If a personal guarantee cannot be avoided, personal guarantee insurance can be a way to mitigate potential personal financial risks.
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Professional image and credibility
Apart from the financial and legal advantages, operating as a private limited company also offers limited company advantages in terms of enhancing your professional reputation. The more rigorous monitoring and complex accounting and reporting requirements that come with a limited company structure can enhance the perception of credibility and trust.
Registering a company name boosts a business’s credibility, signalling to clients and partners that the entity is serious and established. Furthermore, private limited companies can attract investors by offering them a stake in the company through shares, enabling the potential for financial input in company decisions based on the proportion of shares held.
Access to funding and growth opportunities
A limited company structure opens up new avenues for growth and funding. Private limited companies present a lower risk to lenders, potentially leading to more favourable lending rates. They can raise funds for growth through a wider range of sources such as bank loans, venture capital, and crowdfunding.
Easier to raise capital
One key advantage of a limited company structure is the ease with which capital can be raised. Limited companies can issue shares to raise capital, a significant funding tool that does not increase debt.
Directors who prefer not to take on loans can choose self-funded growth by selling shares, thus improving their capital-raising abilities. The structure of a private limited company allows for shared ownership, which can lead to shared decision-making with investors who have an interest in the company’s growth and success.
Expansion potential
Expansion is a primary goal for many businesses, and the structure of a limited company facilitates this. Retained profit allows for reinvestment in the company, funding growth initiatives such as:
- research and development
- marketing and advertising campaigns
- hiring new employees
- expanding into new markets or locations
Retained profit can be accumulated over multiple years to amass significant funding for business investment and expansion. Furthermore, the structure of a private limited company allows for shared ownership, which can lead to shared decision-making with investors who have an interest in the company’s growth and success.
Streamlined administration through Companies House
The administration of a limited company is made more manageable thanks to Companies House.
Companies House’s online service allows for a smooth change of registered office address at no cost, given the address stays within the same part of the UK where the company is registered.
Companies House requires limited companies to update their records and file confirmation statements and annual accounts in a timely fashion, with assistance and clarification available from accountants.
Therefore, engaging with professional accountants such as Sleek is a wise move to ensure compliance with these requirements.
Tailored tax planning and benefits
A limited company structure enables tailored tax planning, bringing additional benefits to the table. Dividends, which are paid from profits after the deduction of Corporation Tax, have specific tax rates different from Income Tax.
The first £1,000 of dividend income in the tax year is tax-free under the dividend allowance, with any amount above subject to dividend tax. Additionally, contributions to a company pension scheme can be treated as a tax-deductible expense, with an annual tax-free limit of £60,000.
Navigating disadvantages with professional advice
Though there are numerous benefits to operating a limited company, it’s crucial to acknowledge the potential challenges. Dealing with the complex accounting requirements of a limited company, which include maintaining company registers and recording decisions, necessitates seeking specialised professional advice.
Professional advice from an accountant is advantageous for handling mandatory public disclosure of personal and corporate information, and it mitigates the risk of personal liability in rare circumstances such as wrongful trading. Therefore, engaging with accountants provides companies with:
- Expertise and understanding of regulations
- Guidance in strategic business structure decisions
- The potential to offset the costs of their services through tax benefits.
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Summary
In conclusion, the benefits of operating as a limited company are manifold.
From the financial advantages of lower Corporation Tax and deductible business expenses to the legal shield of limited liability, to the enhanced professional image and credibility, a limited company structure offers robust advantages.
Notwithstanding the associated challenges and complex requirements, with professional advice, these can be navigated effectively.
FAQs
Yes, it is worth considering setting up a limited company because it can protect against personal liability for business debts and potential tax efficiencies. Limited companies are often considered safer and more tax-efficient than sole traders.
Yes, there are tax benefits to being a limited company, as you may receive income in both salary and dividend form, with dividend income being taxed more favourably than salary and not liable to National Insurance Contributions (NIC).
The advantages of a limited company include paying less tax, limited liability to protect assets, credibility, raising capital, and confidentiality. These benefits make it an attractive option for business owners.
Limited liability separates the business from its owners, protecting them from legal obligations beyond their investment in the company.
As a sole trader, you face the risk of personal liability for business debts and legal claims, along with additional expenses like employers’ National Insurance and pensions when employing staff. Be aware of these financial risks as they can impact your assets.
The disadvantages of a limited company include increased administrative burden and regulatory compliance requirements, such as filing annual accounts and maintaining statutory records, which can be time-consuming and costly.
Limited companies are also subject to higher levels of scrutiny from shareholders, regulators, and the public, which may lead to pressure to deliver short-term results and meet investor expectations.
Furthermore, limited companies may face challenges in raising capital compared to public companies and have restrictions on the transferability of shares, impacting liquidity and flexibility. Additionally, limited companies are taxed at the corporate level, and shareholders may face double taxation on dividends.
Deciding between being a limited company or a sole trader depends on factors like liability, tax, and administrative burden. Limited companies offer limited liability protection, separate legal entity status, and potentially lower tax rates but require more administrative responsibilities and may face higher compliance costs. Sole traders have simpler administrative requirements and greater control but bear unlimited personal liability for business debts. Choosing between the two depends on individual circumstances, business goals, and preferences for risk management and taxation.
Yes, a limited company can have just one shareholder, known as a single-member or sole shareholder company. This structure is common, especially among small businesses and startups.
