The tax benefits of opening a limited company

Always seek advice from a qualified accountant before making any decisions that could affect your income. This guide is a free resource and should in no way be used to make business decisions about your limited company without further research and professional consultation. We’re just here to let you know there are other, perhaps better, ways to work. 

If you’re just starting out as a contractor, you may well be debating whether or not to launch a limited company or to stick with being a sole trader. It can be a tough decision, but many contractors ultimately decide to operate as a limited company as it’s usually the most tax efficient way of operating, as well as limiting the liability of the director – you.

To decide what’s best for you, you’ll need to look at the pros and cons of each option and apply them to your situation, so this feature aims to help you look at some of the main positives and negatives of being a limited company director.

What is a limited company?

Limited companies are the most popular incorporated business structure in the UK. The name derives from the fact that the liability of the company’s members is limited should anything go wrong, with the company being a separate entity to its directors. Usually, a limited company contractor will pay themselves a modest PAYE salary and then draw down the rest of their income in dividends, which are exempt from National Insurance.

A limited company can be set up for a small fee via Companies House and, once you have received your Certificate of Incorporation, you or your accountant will register your business with HMRC.

Limited company vs. sole trader

There are advantages and disadvantages to being both a limited company and a sole trader. Some of them will be more important to you than others. Some contractors, for instance, are all about the tax benefits, while others would just prefer to have less paperwork and responsibility. We’ve laid them out here for you to weigh up.

Pay less tax on profit

With a limited company you’ll pay less tax overall than an employee or sole trader. This is because you can set your salaried income to a lower amount to minimise your PAYE tax contributions. The remainder of your income comes from dividends, but these are subject to a much lower rate of tax.

Reduce NICs

Your National Insurance contributions are also reduced when you act as a limited company director. This is because the dividends you draw down are exempt from NI, increasing the amount of pay that you take home.

Surplus cash retention

If drawing down all of your company’s profits as dividends would leave you subject to a higher rate of tax, you can choose to leave surplus cash in the company. This can be left alone, earning interest, or invested to boost its potential.

Tax-deductible pensions

As a limited company director, you can choose to pay your pension contributions directly from your business’s income, rather than from your own personal funds. This is much more tax efficient as it’s invested before tax deductions.

Business expenses

Limited company contractors have the ability to offset most legitimate business expenses against their corporation tax bill, again allowing for a more tax efficient approach.

More chances of securing a role

Many recruiters and agencies will only work with limited company contractors and won’t offer work to sole traders. So being in a limited company is beneficial in this respect. However, one work-around for sole traders is to operate under an umbrella company in order to secure work through recruiters, although this can have tax implications of its own.

IR35

One negative of being part of a limited company is that you can’t avoid dealing with IR35 and the forthcoming changes to legislation. Sole traders are exempt from IR35 rules and therefore don’t have to deal with it, which is definitely a tick in that column. However, limited company directors can take advantage of IR35 insurance to protect themselves and everyone else in the contractor supply chain in the event of a HMRC enquiry.

Increased responsibility

As a limited company contractor, you also have a number of responsibilities which, legally, you have to take on, but sole traders need not worry about. These include annual accounts, Confirmation Statements and keeping Companies House updated. However, much of this burden can be passed on to a specialist contractor accountant.

So, limited company or sole trader?

Many contractors agree that the financial benefits of operating as a limited company director outweigh the negatives. For a little extra admin, you get to take home so much more of your pay and boost your chances of securing work. You can set it up yourself or recruit an accountant to help you with the administration.

One thing worth bearing in mind is that you still need contractor insurance if you’re operating as a limited company and that’s where the Kingsbridge team comes in. We can help you with business insurances, IR35 insurance and even health cover (which you can purchase through your limited company). So, feel free to call us on 01242 808740 to discuss your requirements.