This is the fourth blog in a series offering advice and guidance to anyone considering starting a new business. We’ll be publishing further blogs over the coming months.
If you’re new to being the owner of a limited company, navigating the tax system can seem complex, but to ensure compliance and make informed financial decisions, it’s essential that you understand the basics.
In this blog, we’re going to present an overview of how tax applies to limited companies – excluding aspects of tax relating to VAT and payroll, which we’ll be addressing in a future blog.
How Tax Applies to Directors of Limited Companies
A limited company is a distinct and separate legal entity from its directors and shareholders. You may be the owner, but any assets, liabilities and profits belong to the company.
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, while directors or shareholders are taxed separately on their earnings.
As the owner and director of a limited company, you will be liable for the following taxes:
a)Tax on your business profits
- Corporation Tax
Limited companies are subject to Corporation Tax on their profits. Corporation Tax is payable at 19% on profits of £50,000 or less, a sliding scale of 19% – 25% applies to profits between £50,000 and £250,000, while profits in excess of £50,000 will attract a rate of 25%.
Reporting & paying Corporation Tax
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 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. 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.
b)Tax on your personal earnings
How your earnings are taxed will depend on how you receive your income. You can choose to extract your income in the form of a salary, as dividends, or, most likely, in a combination of both, balanced to optimise your tax efficiency.
- Income Tax
Any income you take as salary payments are subject to Income Tax and National Insurance Contributions. How much Income Tax you have to pay will depend on your personal circumstances and the level of income you take from the business. Everyone is entitled to an Annual Allowance, qualifying them to earn £12,750 tax-free. Above this, earnings between £12,750 and £50,270 will be taxed at 20%. A higher rate of 40% applies to earnings between £50,270 and £125,000, while earnings over £125,000 will attract an additional rate of 45%.
- National Insurance Contributions (NICs)
As an employee of your limited company, you’ll be subject to Class 1 National Insurance on your annual income from salary and bonuses exceeding your personal annual allowance of £12,570. In addition, your business will be liable to pay National Insurance on employee salaries over an earnings threshold of £9,096 per person: this is the case, even if you are the only individual employed by your business.
- Dividend Tax
Company directors will usually take the larger share of their earnings as dividends. Unlike a PAYE salary, dividends are exempt from any National Insurance contributions. You are entitled to receive up to £3,000 in dividends before paying any tax. The tax due on dividend income over this personal tax-free threshold will depend on the applicable tax band. Rates range from 8.75% for basic rate taxpayers, 35.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.
Reporting & paying Income Tax, National Insurance Contributions & Dividend Tax
Unless you pay yourself through PAYE and receive no income from other sources, you’ll have to complete a Self-Assessment tax return declaring any income you’ve received in the form of salary and dividends – together with any additional income you may have received from other sources.
Each year, you’ll have to complete and file an online Self-Assessment tax return to HMRC by midnight on 31st January following the end of the tax year: this is also the date by which you’ll have to settle your tax bill.
Other things you need to be aware of:
Other things you need to be aware of:
- If you take money out of your business: Because any money in the business belongs to the company and because the company is liable to pay Corporation Tax, owners of limited companies – unlike sole traders or partners – must be careful about how much money they take out of the company.
- Using allowable expenses to reduce your tax liability: You can reduce your Corporation Tax bill by setting allowable expenses against your profit. These can include subsistence and any salary you pay yourself, but not dividend payments.
- If you don’t make a profit: In contrast to sole traders and partnerships, early losses cannot be offset. Only when a limited company is in a profitable position might there be any opportunity to make a discernable benefit from a loss.
- You may need to file two returns in your first year: 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.
Are you considering starting your own business? For more than 20 years, Inca has specialised in working with the owners of micro to small start-ups, helping them build and grow successful, sustainable businesses. 63.9% of the new start-ups we work with get to celebrate their fifth birthday – a success rate more than 300% higher than the national average!