The Advantages & Disadvantages of Operating as a Limited Company: What You Need To Know
A limited company is a legal entity used to protect shareholders’ assets and liabilities. A limited company is different from a sole trader because it has separate directors, officers, shareholders and accounts. This means that a limited company must file annual returns with Companies House. These filings include information such as the name of the company, address, date incorporated, number of shares held, names and addresses of directors and shareholders, and the type of company.
There are pros and cons to establishing a limited company. Some of the benefits include:
• You don’t need to pay tax on profits
• Your personal liability is protected
• You can set up a company without having to register it with Companies House
• You can transfer ownership of the company to another person
• You can sell shares in the company
Top 10 limited company advantages
Limited companies offer greater protection against potential personal liability than sole traders and partnerships. This is because they are usually incorporated into another legal entity such as a partnership or trust. As a result, you cannot be held personally liable for the debts and liabilities of the company.
Companies can also trade under a variety of names, including private limited, public limited, and unincorporated association. These three types of companies are known as “limited”, “public”, and “unincorporated”.
In addition to protecting against personal liability, limited companies also provide additional benefits over sole traders and partnerships. For example, they allow directors to hold shares in the company without having to pay capital gains tax on those shares. Directors also receive dividends from the company, whereas shareholders do not.
1. Minimizing personal liability
Limited companies offer limited liability protection – shareholders cannot be held personally liable for the debts or liabilities of the company. This is because the company itself is considered separate from the individuals who own shares in it. However, there are still some risks involved. For example, if you sell goods to customers without ensuring that they pay you, you could find yourself sued for breach of contract. If you fail to keep proper records, you could face fines and even prosecution under the Companies Act 2006.
2. “Shareholder protection”
If you’re running a sole trader, you’ll be personally liable for anything that goes wrong. You might be able to protect yourself by buying insurance. But if you don’t insure yourself properly, you could lose your home and car, and end up having to repay money borrowed from friends and family.
3. “Protecting assets”
A limited company can help protect your assets from creditors. They can take control of your property if you become bankrupt. And they can often provide tax breaks.
4. “Raising finance”
You can raise money for a limited company by selling shares. Shares are like ownership stakes in the company. They give investors access to profits and losses, and allow them to influence how decisions are taken.
2. Professional status
If you incorporate your business, it will give you a professional image, which will make it easier for potential lenders to find you. You’ll also be able to access a wider range of loans because of this.
When you set up a limited company, you become legally responsible for what happens within the company. This makes it possible for creditors to take legal action against you personally if something goes wrong. If you’re incorporated, you won’t be able to hide behind your personal assets.
You’ll want to choose a name that reflects your business’ purpose and ethos. For example, if you run a restaurant, don’t call yourself “The Restaurant Company.” Instead, use your name – such as “Cafe X”.
3. Tax efficiency and planning
Limited companies in the UK currently pay 19% Corporation Tax (CT) on profit, whereas sole-traders pay between 20% and 45% Income Tax (IT) on their profits. This article explains how limited companies are taxed differently to sole traders.
The main difference is that limited companies must declare their taxable profits every year. Sole traders do not have to report their profits annually; however, they still have to pay IT on their earnings.
If you operate as a limited company, you don’t have to pay CT immediately upon making a profit. Instead, you can defer paying it until a later date. You can use the following methods to defer paying CT:
• Investment – If you invest the money in shares, bonds or property, you can reinvest the proceeds without having to pay CT again.
• Dividends – If you receive dividends from another company, you can keep those dividends without paying CT on them.
• Capital gains – If you sell assets such as land or buildings for more than what you paid for them, you will make capital gains and can defer paying CT on them. However, you cannot defer paying CT on the gain itself.
• Interest – If you borrow money from a bank or building society, you can defer paying CT on interest payments.
4. Higher personal remuneration
A limited company can help you save money on taxes. You can deduct expenses against profits, such as rent, interest payments, advertising costs and even some legal fees. The amount you can claim depends on how much profit you make each year. If you are self-employed, you can deduct 50% of your total income.
You can also use a limited company to get the benefit of the dividend allowance. This allows you to reduce your taxable income by up to £5,000 per person (£10,000 for couples).
Limited companies can provide other benefits too, including pension schemes and share options.
5. Separate legal identity
Limited companies are legally distinct entities from the people who run them. This makes it possible for them to do things like buy property, borrow money, hire employees, sell goods, invest in other businesses, and even make donations to political parties.
A limited company is owned by the shareholders who must pay tax when the company earns profit. Shareholders cannot avoid paying taxes, even if they don’t earn any income themselves. However, they can choose whether to take dividends out of the company or reinvest them into the business. If they decide to reinvest the dividend, they’ll end up owning shares in the company again.
The company itself doesn’t pay tax. Instead, the shareholders pay personal income tax on the dividends they receive. In some cases, the company might pay corporation tax on behalf of its shareholders.
6. Credibility and trust
Limited companies are often used by businesses that want to protect themselves against personal liability. This includes organizations such as law firms, accountants, and consultants. A limited company offers additional benefits over sole proprietorship. These include:
• Additional protections against personal liability
• Greater protection against bankruptcy
• Better tax deductions
• More flexibility
The advantages of having a limited company outweigh the disadvantages. If you decide to form a limited company, make sure you select one that meets your needs.
7. Investment and lending opportunities
Shareholders generally have less control than directors over how money is spent. This means that shareholders often don’t know what the company is doing with their money. Directors, however, are held accountable for how the company spends shareholder funds. When a company is incorporated, it becomes a legal entity separate from its owners. As such, it can take out loans and make investments without having to ask permission from its shareholders. A bank will typically loan money to incorporated companies because they are legally obligated to do so.
8. Protecting a company name
A company name is one of the most important assets you have in your business. A company name is like a brand; it represents everything about your business. Your company name is what people think of when they hear your name. If you want to keep your company name protected, there are a number of things you need to know.
1. Register your company name
Registering your company name gives you protection against someone else registering the same name. You can register your company name online with Companies House. This costs £30 per year.
2. Keep your company name secret
You can use your company name in trade without having to tell anyone. However, you do need to make sure that no one else uses your company name in trade. To avoid confusion, you need to ensure that everyone knows that your company name is yours.
3. Use your company name properly
Your company name needs to be easy to remember and easy to spell. It shouldn’t include words such as ‘the’ or ‘and’ because those words take up space in a web address. It’s best to stick to single words rather than phrases. For example, rather than calling yourself ‘The Plumbers’, call yourself ‘Plumber Services Ltd’.
9. Pensions
Companies provide the opportunity to invest into a company pension scheme. These pensions offer tax relief for both employers and employees. For example, companies can deduct up to £40,000 per employee each year against profits. Employees can claim 25% off their annual salary towards their pension contributions. This is known as National Insurance Contributions (NIC).
The government offers incentives for people to save money in their workplace pension plans. If you contribute to a pension plan, you receive a personal allowance of £4,000 per annum. You can also earn additional income tax allowances of 10%, 20% and 30%.
Businesses often set up their own pension fund. In return for setting up a pension scheme, businesses must pay a levy to HM Revenue & Customs (HMRC). The amount paid depends on how many employees are employed within the organisation. There are no limits placed on the size of the contribution. However, there is a limit on the total amount that can be contributed to the scheme.
A company pension scheme allows employees to make regular payments into a pot. Once the pot reaches a certain level, it becomes fully funded. At retirement, the employer pays out a lump sum based on the value of the funds accrued during employment.
There are different types of pension schemes. Some are defined benefit schemes. Others are defined contribution schemes. Defined benefit schemes guarantee a fixed monthly payment upon retirement. Defined contribution schemes do not guarantee a specific payout. Instead, the employee receives a lump sum at retirement.
Employers choose to offer a range of options to their workers. They can opt for a basic pension, a cash balance pension or even a final salary pension. A cash balance pension involves making regular contributions to a pension fund. The employer makes a lump sum contribution at retirement. The worker receives a guaranteed payout based on his/her age and length of service.
If you decide to invest in a company scheme, you can use the same rules as those used for investing in the stock market. You can buy shares, bonds, ETFs or mutual funds.
You can also use the same rules to sell shares, bonds, ETF or mutual funds.
10. Splitting income
You can issue shares to your spouse and other family members if you are the proprietor of a corporation limited by shares. This will allow you to divide the profits of your firm and lower your personal tax burden.
By, for example, paying your spouse or children dividends, you can benefit from their tax-free Personal Allowance, basic tax rate, and £2,000 tax-free dividend allowance. This is very helpful if you are the sole or primary wage earner and/or consistently provide financial support for your children.
Disadvantages of a limited company
Companies House charges £495 to register a company. You must pay a fee even if you don’t want to use the service. If you’re starting up a small business, it might be worth paying the registration fee. However, if you already have a registered company, you’ll probably find it cheaper to keep the existing company name.
Public records – Directors details will now be published online. This includes information about directors’ names, addresses, occupations and contact numbers. When you apply to become a director, you’ll need to provide certain personal details. These include proof of identity, address and occupation.
Complex accounting – Accounts are very complicated. They contain lots of detail, such as how much each person owns, what each asset is worth, and how much tax you’ve paid. Accountants usually charge around £500 per hour.
Raising capital restrictions – Shares can’t be sold unless you raise additional funds. For example, shares can’t be sold unless the company raises extra cash. Shareholders can sell their shares to another investor, but they won’t receive payment until the company raises enough money to buy them back.
Withdrawing money from a limited company – A company rule restricts withdrawals. If you withdraw too much money, you could face fines or imprisonment.
Annual accounts – Must be filed every year. Your annual report contains financial statements showing how much profit the company made during the previous 12 months.
Limited companies are often seen as ‘the safe option’. In most cases, you don’t have to file accounts. Instead, HM Revenue & Customs sends you a statement once a year.
But there are many disadvantages to being a limited company.
There are many advantages to being an unlimited company.
About sole trader businesses
A sole trader business is one where there are no employees working under the umbrella of another person. This makes it different from partnerships, limited companies and corporations. A sole trader business is owned solely by the individual who runs it.
The term “sole trader” refers to someone who owns and operates a business without employing anyone else. They do everything themselves, including paying bills, managing accounts and making decisions about how to run the business.
This type of business structure is most common among freelancers, consultants and self-employed people.
There are many advantages to running a sole trader business. For example, you won’t pay corporation tax and you’ll save money on payroll costs. You’ll also avoid employment law obligations like holiday pay, sick pay and maternity/paternity leave. However, you must take care to ensure that you’re compliant with HMRC rules and regulations. If you fail to do this, you could face penalties and fines.
You’ll also need to keep accurate records of your income and expenses. These records will help you meet your tax liabilities and make sure you’ve paid enough National Insurance contributions during each tax year.
If you want to start a sole trader business, here are some things you’ll need to consider:
1. What sort of business are you planning to set up?
Pros and cons of the sole trader structure
The sole trader structure offers many advantages, including being able to work from home and avoid paying corporation tax. But it does come with disadvantages, such as having no legal protection against debtors and creditors. Here we look at the pros and cons of working as a sole trader.
Limited company or sole trader?
Which one makes sense for you?
There are pros and cons to both types of business structures. For example, limited companies allow you to raise capital without having to go through complicated corporate registration processes. However, they do come with certain limitations. Limited companies must be registered under the Companies Act 2006, and they cannot provide professional advice or act as intermediaries. They must appoint directors and shareholders, and they can only hold shares in another company.
Sole traders don’t require any formalities. You can set up a business as a sole trader without registering it with HM Revenue & Customs (HMRC). This means you won’t pay corporation tax, VAT, national insurance contributions, or income tax. As long as you keep accurate records, there are no audits, penalties, or interest charges. But you still have to file accounts every three months. If you fail to do so, HMRC could fine you £10,000 per month.
If you want to run a business out of your home, you can choose either option. A limited company requires less paperwork, but you’ll need to register it. Sole traders don’t need to file any documents with HMRC, but you’re required to submit quarterly returns.
Self Assessment for directors and sole proprietors
If you are a company director or a sole trader, you must complete Self Assessment by 5th October 2018. This includes filing your accounts for the previous financial year and paying any tax due. You do not need to pay anything now, but it is important to act quickly because there is no grace period.
HM Revenue & Customs (HMRC) will send you a reminder about the date by email or post.
Frequently Asked Questions
Limited or sole proprietorship?
A company creation will give you with minimal liability if your business experiences financial difficulties.
Additionally, limited liability corporations enjoy superior tax advantages, including corporation tax.
Remember that a limited liability corporation has a standing that a sole proprietor does not.
Keep in mind that a limited liability company has status that a lone proprietor does not. This can generate business and allow you to enter into contracts that you were previously unable to as a sole proprietor.
There are additional disadvantages to a limited liability company. Companies Time is required for house registration, which a small firm may not have. In addition to needing to pay for the pleasure of doing so, additional costs are incurred.
Accounting and bank account management will be more demanding for a limited liability company than for a sole owner.
Considering that establishing a sole proprietorship is free and that day-to-day administration is low, this is an important consideration for business owners. Time is, after all, money.
In terms of business structure, a sole proprietorship is ideal for freelancers or small businesses, as the tax ramifications should not be as significant at this point.
Do I pay more tax as a sole proprietor or as a corporation?
Before deciding how to manage your business, you may want to consider how much tax you could save based on the business structure, in addition to the pros and cons of both business structures.
We have provided the following comparison table:
2021/22
Profit Ratio
£10,000
£20,000
£30,000
£40,000
£50,000
£75,000
£100,000
Sole Trader
£198.00
£2,583.48
£5,483.48
£8,383.48
£11,283.48
£21,748.38
£32,248.38
Private Company
£220.00
£2,369.00
£4,876.00
£7,384.00
£9,891.00
£19,200.00
£30,531.00
Saving
-£22.00
£214.48
£607.48
£999.48
£1,392.48
£2,548.38
£1,717.38
2022/23
Profit Ratio
£10,000
£20,000
£30,000
£40,000
£50,000
£75,000
£100,000
Sole Trader
£175.00
£2,687.10
£5,712.10
£8,737.10
£11,762.10
£22,539.50
£33,352.00
Private Company
£171.00
£2,364.91
£7,582.41
£10,191.16
£19,265.29
£30,849.66
Saving
£4.00
£322.19
£738.44
£1,154.69
£1,570.94
£3,271.21
£2,502.34
Note that new corporate tax rates will take effect for the 2023/24 tax year beginning April 6, 2023. Therefore, the following information will remain accurate for limited corporations with a year-end date of up to March 31.
In general, if your profits exceed £50,000, you should consider forming a limited liability company in order to take advantage of tax measures that will minimize your tax exposure. Below this earnings threshold, working as a single proprietor provides greater tax benefits. Additionally, it is far easier to convert a sole proprietorship to a corporation than the other way around. If you need assistance forming a limited liability company, please contact us for a free consultation to discuss how we can assist your new firm.
