What is a limited company?
A limited company is a business that is a separate legal entity from its owners who are referred to as shareholders. A limited company must be incorporated at Companies House and is governed by the requirements of the Companies Act and its own Articles of Association (rules on how the company operates). A limited company must submit an annual return updating company information to Companies House, as well as submit company accounts for each tax year to HMRC. The information about the company and its directors is held on a public register and available for anyone to view.
How does a limited company work?
Once a limited company has been set up it can enter into contracts, employ staff and will be responsible for any debts and liabilities incurred. A limited company is run by a director, or directors, and it is their responsibility to conduct the company in a legal manner complying with all relevant legislation and in line with their Articles of Association.
Directors of a limited company must be over 16 years of age, and not been previously disqualified as a director. but they do not have to be employed by the limited company or own shares in the company.
What are the benefits of a limited company?
Setting up your business as a limited company limits your personal liability for debts and other liabilities incurred by the business. If a limited company runs into financial trouble the only risk you will have as a shareholder is the amount you paid for the shares together with any unsecured loans made to the company.
Creating a limited company will have a positive effect on how your business is perceived by customers and suppliers and will also improve your ability to raise finance if required.
The taxation of a limited company is different from that of a sole trader and this could reduce the overall tax burden for the directors and shareholders. Payments made to directors can be either through a salary or dividends and you also have the ability to lend money to directors from the business.
What are the disadvantages of a limited company?
Separate legal entity
A limited company is a separate legal identity to a sole trader which means that all assets belong to the company and not an individual as with a sole trader.
Additional reporting requirements
There are certain legal reporting and filing requirements that a limited company has to comply with and certain details are held on the Companies House register which is available for the public to view.
The accounting and taxation requirements for a limited company are more complex and therefore more costly than for a sole trader.
If there are a number of different shareholders they may have different visions about the future direction of the company. If one or more of the original shareholders dies then their shares may be inherited by individuals with no real interest in the company.
How is a limited company taxed?
A limited company will pay corporation tax on their total profit, less allowable expenses. Companies with profits in excess of £250,000 will pay corporation tax at the rate of 25% and those with profits of £50,000 or less will pay corporation tax at the rate of 19%. Businesses with profits of between £50,000 and £250,000 will pay 25% corporation tax, however, they can reduce their corporation tax bill using 'Marginal Relief'. Marginal relief provides a gradual increase in the rate of corporation tax, between the small profits rate and the main rate, effectively allowing businesses will smaller profits to pay a lower rate of corporation tax.
In addition to corporation tax any dividend paid to shareholders is taxed as follows:
Each shareholder will have a total tax-free dividend allowance of £1,000 (2023/24). All dividends received in excess of that amount, will be taxed depending on their current marginal rate of income tax. Dividends received will be added to any other income received in the same tax year and the following rates will be applied.
|Tax band||Dividend tax rate|
You receive £4,000 in dividends and earn £30,000 in wages in the 2023/24 tax year.
This gives you a total income of £34,000. You have a Personal Allowance of £12,570. The table below shows the rates of income tax paid on your earned income
|Tax band||Taxable income||Tax rate|
|Personal Allowance||£0 to £12,570||0%|
|Basic rate||£12,571 to £50,270||20%|
|Higher rate||£50,271 to £150,000||40%|
|Additional rate||over £150,000||45%|
This means that:
- no tax on £1,000 of dividends, because of the dividend allowance
- 20% tax on £17,430 of wages
- 8.75% tax on £3,000 of dividends
This equates to a total of £3,748.50 in tax.
How do I set up a limited company?
Decide if it's right for your business
Setting up a business as a limited company is more expensive than simply registering as a sole trader or partnership due to the additional legal and accounting requirements.
Choose a name
When setting up a limited company you have to choose a name for the company which cannot be the same or too similar to another company's name or trademark.
When deciding on a name for your company it may be advisable to use a name that is broad or vague in its meaning so that it doesn't narrow the public's view of your business if you expand into other areas. If you have already got a recognised business, as a sole trader or partnership, you can create a limited company with a different name and retain your current business name as a 'trading name'.
Decide on the directors
A limited company must have at least one director but there is no upper limit to the number of directors. A director must be over 16 years of age but does not need to be employed by the company or a shareholder of the company.
As a director you will be responsible for:
- ensuring the company is run in line with the rules shown in the Articles of Association
- maintaining company accounts and records
- filing the company tax return and ensure all taxes due are paid
- informing other shareholders if you might personally benefit from any transactions the company makes
These responsibilities can be managed by a third party such as an accountant but the legal responsibility remains with the director(s).
Decide on the shareholders
When forming a limited company there is no limit to the number of shareholders but it makes sense to limit shareholders in a small business to those closely involved in the business. The price of each individual can be set at any price but as shareholders will need to pay for their shares in full if the company goes into liquidation a share price of £1 is often used.
Shares can be created with different rights with regards to dividend payments or voting on company issues. These different share rights can be registered by creating share classes, so, for instance, a limited company can have Class A, Class B and Class C shares which will allow the company to pay different dividend amounts to each class of share.
Registering your limited company
At this point I would consider, if you have not already done so, employing the services of an accountant. Whilst you can carry out the work involved in setting up and running a limited company yourself employing the services of an accountant can make life so much easier and make sure you comply with all the current legislation.
Identifying people with significant control
From 30th June 2016 UK companies have had to register individuals who have significant control over the company. A person of significant control is someone that holds more than 25% of shares or voting rights in a company.
Memorandum and Articles of Association
If you register your company online, you don’t need to write your own memorandum of association. It will be created automatically as part of the registration process. Articles of Association can be created by yourself or download the HMRC Model articles.
Understand the records you will need to keep
As a limited company you must keep comprehensive accounting records for the following areas:
- assets owned by the company
- income and expenditure
- debts owed by the company or to the company
- employee details
- amount of stock held if any
All financial records must be kept for a minimum of 6 years.
Register your company with Companies House
You can register a new limited company at Companies House online for a fee of £12 (£40 by post) and you must provide full details of directors and shareholders, the registration process usually takes around 24 hours. Once registration is completed you will receive a registration certificate together with a company number.
If the new limited company is going to start trading immediately then you will need to register the company for Corporation Tax and PAYE for employers if you are employing staff. This again can be completed while registering your company with Companies House via its official online tool.