Advantages and Disadvantages of a Limited Company
Navigating the intricate landscape of self-employment is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: Limited Companies. But what are the advantages and disadvantages of a limited company?
In this comprehensive guide, we delve deep into the heart of limited companies. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to empower you with the knowledge to make informed decisions.
Advantages of a Limited company
The most significant advantage of a limited company for most people is limited liability. However, there are many additional benefits to working through a limited company, including:
- Tax efficiency;
- Professional status; and
- Transfer of ownership.
i) Limited Liability
A limited company is a legally distinct entity, providing a barrier between the shareholders’ personal assets and the company’s financial obligations. While working through a limited company, your responsibility for the company’s debt is restricted to the value of the shares you own in that company.
Unincorporated businesses, like sole traders, place no distinction between the business and the individual. All business finances and liabilities are the owner’s responsibility, and if the business were to suffer financial hardship, their personal assets are at risk.
ii) Tax Efficient
A limited company is a tax-efficient business structure. The business’s expenses (including wages) can be offset against corporation tax, while the owners can minimise their tax burden by paying themselves a specific combination of salary and dividends.
Owners of limited companies can also defer tax obligations by leaving surplus profit (known as ‘retained earnings’) in the business bank account and withdrawing it in a later tax year.
iii) Professional Status
The limited company structure creates a professional image. While the business activities and management practices may be the same as if you were a sole trader, your company will be held in higher regard.
This added credibility is due to the statutory obligations to which limited companies are subject.
As a limited company director, you must ensure your business meets its reporting requirements. From confirming ownership details to filing annual accounts, everything a limited company does is closely recorded and available on public record via Companies House.
his transparency is why most organisations prefer working with limited companies, and you could miss out on many lucrative opportunities if you don’t incorporate.
iv) Transfer of Ownership
A limited company can easily transfer ownership of existing shares. As the company is a separate legal entity, all assets are registered under its own name. Transferring business ownership is far simpler than with a less formal structure.
Adding additional individuals (e.g., a spouse) to the shareholder register is also possible, thereby splitting the business’s profits. If done in line with the relevant HMRC legislation, transferring ownership this way efficiently reduces tax liabilities.
Disadvantages of a Limited company
Very few disadvantages of the limited company structure could convince you not to incorporate your business.
i) Initial Setup
As a sole trader, setting up your business is free, as you are the business. There is no legally distinct entity. All you need to do is register for self-assessment. To incorporate a limited company, you must go through a structured process on the HMRC website and pay a one-off fee of £12.
While incorporating a limited company may seem daunting, you can hire an incorporation service to do it for you.
ii) Ongoing Administration
Some individuals may find the additional reporting requirements that come with being a limited company director a burden. Maintaining appropriate records, submitting annual accounts and filing tax returns can be time-consuming.
Fortunately, limited company accountants can help ease this administrative burden.
Accountancy Fees
While it is true that accountancy fees for a limited company can be more expensive than those for a sole trader, the disparity between the two is no longer as significant as it once was. It’s also worth remembering that accountancy fees are tax-deductible, reducing your corporation tax payments.
Contractors and Limited Companies
As a UK contractor, you may read the above and understand why, in principle, business owners usually decide to operate via limited companies. But why do contractors specifically prefer this type of business structure?
i) Higher Take Home Pay
For contractors working Outside IR35, providing services via a limited company is the most tax-efficient option. Limited company contractors are not subject to PAYE like permanent staff or umbrella company contractors.
They can pay themselves a combination of salary and dividends that minimises income tax and National Insurance contributions and maximises take-home pay.
ii) Expenses
As a limited company contractor, you can expense costs that are ‘wholly and exclusively’ for the purposes of running your business, from accountancy fees to IT equipment, phones, travel, and your home-office. They are offset against your company’s revenue, reducing the corporation tax you pay to HMRC.
These expenses are far broader than those available to umbrella company contractors working Inside IR35.
iii) No Choice
If you want to work on Outside IR35 contracts, you often have no choice but to provide your services via a limited company. Due to the rules around IR35 and sole traders, almost all agencies and end-hirers will refuse to work with sole traders.
You could opt to work via an umbrella company, although most contractors will dismiss this as an option for outside IR35 contracts due to significantly reduced take-home pay.
When Is A Limited Company Right For Me?
In general, a limited company is right for you if:
- Your contract is Outside IR35, and
- You intend to contract for the long term (six months or so).
If either of these criteria isn’t met, you may want to consider working through an umbrella company.