Limited Companies – What they are and the advantages of trading this way

Limited companies are one of the most popular legal structures for businesses in the UK. However, they won’t necessarily be the best solution for everyone. Therefore, to enable you to make an informed decision, we have outlined below the main advantages, as well as some of the potential downsides to a limited company to help you.

Of course, you are always welcome to speak with someone in the Kennedys Accounting team about why you are looking to incorporate a limited company, or just a chat about the right structure for you.

The main reasons clients tell us that they want to incorporate a limited company is due to tax efficiency, sometimes status and often due to limited liability. But what does this all mean and why does it make sense to trade in this way.

Status of being a limited company - is it important?

Some people believe that their professional status/image will improve when they trade as a limited company. Whilst the ownership structure, management of the business and what you ‘actually do’ may not have changed since you may have operated as maybe a sole trader, limited companies seem to be held in much higher regard and create a better impression – but is this just perception?

Maybe this perception stems from the fact that limited companies are monitored. The accounting for limited companies is more complex and there are rigorous reporting requirements, as well as compliance obligations. You also need to employ the services of an accountant due to the software required to file limited company accounts.

Details of the Directors, Shareholders and the company registered office are shown on Companies House. These are therefore available for other businesses and members of the general public to view the record. An easy way to prove that you are a limited company.

The fact that you are easily found as a limited company, can certainly be an advantage, which includes but is not limited to the following;

attracting new clients and investors
accessing a wider range of lending opportunities - although banks may still request a personal guarantee if they lend money to a limited company.
creating a trusted brand identity
easy to find your competitors and see how their business is trading.

Personal liability – what does this mean?

It is often portrayed that a benefit of forming your own company is that you can effectively ‘walk away’ if the business gets into trouble. This is known as limited liability – but how does this really work?

When it is formed a limited company is treated as a separate legal entity. So in simple terms this means that the company is entirely separate from those who own (shareholders) and manage (usually directors) the limited company. This means that your personal assets will be secure.

Furthermore debt, losses, or legal claims associated with the company are the responsibility of the company itself – not its owners or directors. If you are a shareholder, you will have no legal obligation to pay more than the nominal value of the shares you hold in the company.

However, there are instances, such as fraud or wrongful trading whereby you may not have that protection. Especially if due diligence wasn’t completed sufficiently or you knowingly entered into a deal which you knew was not lawful. This would result in shareholders (and directors) being personally liable for company debts.

This is not an area (as above) that you can potentially do ‘anything about’. If such a situation did arise while running your limited company, you may still be forced to use your own assets to cover any liabilities if you gave a personal guarantee to the company or you were found guilty of wrongful trading or a criminal act.

3. Separate legal identity – how is this different?

A limited company is a bit like a ‘legal person’ in their own right. Effectively it has an entirely separate identity from its shareholders and directors. As a result, companies can enter into contracts in their own name and are responsible for their debts and liabilities. When you incorporate a limited company and you are the director. It is important that you remember you and the company are not the same person!

If the business does all ‘go wrong’ the shareholders are liable for the value of their unpaid shares or personal guarantees, rather than the full extent of the company’s liabilities. Therefore if a company becomes insolvent, it is the business itself that is declared bankrupt, not the shareholders or directors. (Subject to the comments above)

Another consideration with regards to a limited company is that they can literally operate for years and years. Often outliving the original shareholders and directors and businesses are sometimes passed from generation to generation or sold to other people and continue to exist with minimal disruption, if any, to the staff and the customers.

The limited company name – what will it be?

Every company has a name which is unique, registered and agreed by Companies House when the company is incorporated. The official name of your company cannot be registered and used by any other business, meaning that two companies cannot have the same name.

You may also find yourself in trouble if you set up a name similar to one that is already established and trade in a similar product or service – this is known as ‘passing-off’ and can rightly land you in trouble.

Corporation Tax – how is this tax calculated and what is it for?

As explained previously, a limited company is its own legal entity and therefore pays tax on its profits. This tax is called corporation tax.

The corporation tax rate is set by the government in the budgets the same as personal tax.

However, unlike being a sole trader where all of your profits for the year are taxed in that year, with a limited company, you have some options, a couple of which are below;

Surplus Cash can be reinvested
Instead of withdrawing all available profits each year and paying personal tax, you can retain surplus income in the business to invest for future costs and growth. This makes more sense than withdrawing all profits, paying higher rates of Income Tax, and reinvesting your own finances when the business needs additional money
Deferring personal income
You could defer the withdrawal of profits to a later tax year. This is an efficient strategy if the withdrawal of all available profits would take you into a higher Income Tax band.

Higher personal remuneration – how? by ‘paying yourself’ in a different way

As a Director of a limited company you could look to reduce your Income Tax and National Insurance contributions (NIC) by taking a combination of a salary and dividends (see details below).

So….lets explain….

If you are a director and you keep your salary below the NIC primary threshold, you will not have to pay any Income Tax or employee Class 1 National Insurance on those earnings. Furthermore, the company won’t have any Corporation Tax liability on the salary, because wages are a tax-deductible business expense.

But don’t worry, you don’t have to live on that amount….

The rest of your income can be taken as dividends, which are paid from profits after Corporation Tax is paid. You will also benefit from the annual Dividend Allowance. Above this sum, you will be required to pay dividend tax. However, dividend tax rates are lower than Income Tax rates. Depending on your annual profits, you could save money in tax every year by operating as a limited company.

Do customers trust a limited company?

The status of being a limited company structure can add credibility to your business. Some businesses are only prepared to engage with other incorporated businesses for a number of reasons.

What are the disadvantages of a limited company?

Although some might argue that there are some disadvantages to a limited company, if you consider the potential tax advantages and enhanced professional image alone, this is unlikely to be the case.

Some disadvantages are as follows:

you will be required to pay an incorporation fee to Companies House to get the company set up
personal and corporate information will be disclosed on the public record
accounting requirements are more complex and time-consuming
you will likely need to appoint an accountant to help you with your tax affairs
strict procedures must be followed when withdrawing money from the business – remember the money belongs to the company – not you!
a Confirmation Statementand annual accounts must be filed at Companies House each year
a company tax return and annual accounts must be delivered to HMRC every year.
companies are required to adhere to strict record keeping, including taking minutes of meetings to record all decisions taken by directors and shareholders
if you make any changes to your company details, you must notify Companies House immediately

If you are now ready to incorporate your limited company, here at Kennedys Accounting we will be happy to help. Please get in touch with our customer experience team for more information – we look forward to hearing from you.