It’s very likely your status as a taxpayer will change several times throughout your working life. As an employee, having tax deducted at source through PAYE makes your tax affairs relatively straightforward. But when your entrepreneurial spirit drives you to set out on your own, and you become responsible for reporting income and paying tax yourself, things become a little more complex.
Depending on whether you decide to operate your business as a sole trader, a partnership, or a limited company, the way your tax is calculated, how you pay it and when it’s due for payment will be different. And as your business evolves, you may well opt to move between models to suit your changing needs and optimise your tax efficiency.
In the final blog of our series looking at how tax works in different business models, we focus on limited companies.
Limited Company: Overview
A private limited company is a distinct and separate legal entity from its directors and shareholders. Whilst the directors might also be the owners, any assets, liabilities and profits belong to the company.
As the name implies, a limited company offers a level of protection: shareholders cannot be held wholly responsible for any debts a company incurs, and their liability is limited to the value of the shares they hold in the business. If a company fails, the director’s personal assets are not at risk (as long as they have operated the business correctly).
How & when are taxes paid?
Unlike a sole trader or partnership, where the individuals running the business are responsible for paying tax, in a limited company, the business itself pays tax on any profits it makes, and the directors or shareholders are taxed separately on their earnings.
Owners of limited companies typically remunerate themselves through a blend of salary and dividends – balanced to optimise their tax efficiency. The larger share of earnings will usually be taken as dividends. Unlike a PAYE salary, dividends are exempt from any National Insurance contributions and attract a lower rate of Income Tax, giving limited company owners a financial advantage of about 4.25% compared with a sole trader or partner making the same level of profit.
When a limited company starts to make profits over £50k, the tax advantage for the owner begins to accelerate further: The point at which the owner as a sole trader must pay tax at the higher rate is delayed because the company will pay the tax first on its share of the profits.
Tax obligations & liabilities
When you set up a limited company, your personal and business finances must be kept entirely separate. You will be responsible for meeting all your tax obligations and liabilities – for the company and for yourself as director and owner.
- Company tax return
You must file a tax return for your company with HMRC each year, reporting whether the company has made a profit or a loss and how much (if any) Corporation Tax (see below) it must pay. Even if your company makes a loss or there is no Corporation Tax to pay), you must still complete and file a return.
While sole traders and partnerships are required to file their tax returns by the end of the tax year, the filing deadline for a limited company is determined by its financial year-end, which can be any time. Company Tax Returns must be filed with HMRC 12 months after the accounting period covered. However, the tax bill must be paid 9 months after the end of the financial year, and Companies House requires the accounts in the same 9-month timescale.
Many limited companies choose to align their financial year to the tax year, but this really only benefits companies operating in the construction sector and suffering CIS deductions. Since these deductions are part of payroll and aligned with the tax year, companies can use them immediately to offset any corporation tax liability.
In the first year of trading, many owners of new limited companies are caught out by the fact that they may have to file two tax returns. The period covered by the tax return (the ‘accounting period’ for Corporation Tax) cannot be longer than 12 months, but a company’s first accounts will start on the day it was incorporated and end on the last day of the month of incorporation – a period which may exceed 12 months, requiring two returns to be filed.
- Corporation Tax
Limited companies pay Corporation Tax on any profit they make. Currently, the Corporation Tax rate is 19%, but in the 2021 budget, the Chancellor announced this will be increasing to 25% starting in 2023. However, a new small profits rate will maintain the 19% rate for companies with profits of £50k or less, and there will be a taper on profits over £500k.
The accounting period for Corporation Tax is the time covered by your tax return, and the deadline for paying any Corporation Tax due is nine months and one day after the end of your accounting period.
You can reduce your Corporation Tax bill by setting allowable expenses against it. These can include subsistence and any salary you pay yourself – but not dividend payments.
Many people think a limited company must be registered for VAT, but this is not the case. Registration is dependent on sales, not structure. You may select to voluntarily register for VAT because it benefits your business, but registration is only compulsory for companies with a turnover of £85k or more.
- Income Tax & National Insurance
Any salary you pay to yourself or to any employees you have will be subject to Income Tax and National Insurance. These will be deducted at source through your payroll.
In addition to the taxes your limited company will be liable to pay, you will also be responsible for paying tax on any income you receive personally. You will need to complete a self-assessment tax return, declaring any income you’ve received in the form of salary and dividends (you may also need to declare and pay tax on any company assets you have access to).
Your return must be filed and any tax you owe settled by 31st January following the end of the tax year to which it relates.
Is it a legal requirement to appoint an accountant?
The short answer is ‘no’. There’s no legal obligation on you to appoint an accountant, but there are many benefits to doing so. A good accountant will do far more than simply file your VAT returns (if you’re VAT registered) and compile your annual accounts. They will be proactive in providing advice all year round, helping you make sound financial decisions, and retain as much of your earnings as possible by ensuring your tax efficiency is optimised as you grow. The value your accountant will add to your limited company business will cover the cost of their services many times over.
Are you about to launch a new business and wondering if setting up a limited company is the best route? Are you already running a small, limited company and in need of advice regarding your accounts or finances? Since we set up Inca 20 years ago, we’ve focused on working exclusively with small businesses and count hundreds of limited companies among our clients.
We support business owners with all the advice and tools they need to survive and thrive: 63.9% of the start-ups Inca works with get to celebrate their fifth birthday – the national average is just 40% – just one of the reasons why we enjoy a client retention level in excess of 96%!
Get in touch with one of our advisors today to find out more about the services Inca provides and how we can help you.