There could be tax savings, but you have to weigh up the additional costs a limited company can bring
In last week’s article I mentioned that setting up in business could involve forming a limited company, but that this was not always a great idea.
Today I am going to flesh out some of the factors to be considered if thinking of setting up a company.
Firstly I will address sloppy language. Often one meets someone in business and they say they have a company. They may even say they are a director.
You need to exercise caution before assuming that they are a director of a limited company. They may simply be a sole trader or partner in a business. It may not be a limited company.
What then is a limited company? The name means limited liability and this relates to the exposure of the shareholders if the company goes belly-up.
If you are a sole trader or in a partnership then all your personal assets (including your home) are at risk if your business fails and owes money to people or organisations.
By having a limited company you will probably limit your exposure to business debts. In general if you run the company properly, and behave honourably, then you will not be personally liable for debts of the company.
Having said that it is an offence to continue to run a company which has become insolvent — i.e. is unable to pay its debts.
Are there categories of people for whom a limited company is more suitable? The exposure to debts issue is important here.
If you are going into business with a friend or associate, the last thing you would want would be to have to lose your savings over business debts, perhaps made worse by your partner.
Setting up a limited company provides both of you with a little protection and comfort. You might still lose all you invest, but hopefully no more than that.
Is it expensive? The formal setting up of a limited company costs under £200 and there are a couple of company shops and registration agents in Belfast to do it all.
The main costs come later in the form of extra accountancy costs and the extra burden of running as a company.
Naming a company is not without its restrictions. For all business names, including companies, there are rules on words you cannot use, or cannot use without permission.
The permission might come from Companies Registry (for example, using the words Irish or British) or some other body. For example you cannot just decide to set up a business with the word dentist in it without permission from the General Dental Council.
Companies Registry guidance on names can be accessed by clicking on the pdf at http://tinyurl. com/ad83aw
Employment hassles come with setting up even the smallest companies. If you set up as a sole trader and employ no one then employment rules are of no interest to you.
If, however, you set up a company and you are the only director then suddenly employment responsibilities land on your desk. Your company now has an employee (you.) The employer (the company) must obey all the usual employment law restrictions on length of working week, payment of National Minimum Wage, annual paid holidays etc. HM Revenue & Customs will expect the company to obey all the Pay-As-You-Earn rules on deducting tax and National Insurance from your salary or wages.
Will you save tax? This is the most common question I am asked about setting up a company. The answer is often a woolly “It depends...”
This is because a lot of factors will come into the sums. How much profit the business is likely to make, how much income you need to extract to fund your lifestyle, whether you need a given level of salary to obtain a mortgage (or will salary plus dividends count?) and so on.
In general terms, here are a couple of important facts about company tax:
- The tax is payable in one lump sum nine months after your year-end.
- For most trading companies the tax is currently at 21% on profits (year 2008/09).
- Profits are worked out before dividends are taken for shareholders.
- If your dividends plus salary plus other income exceed £41,475 (2008/09 figures) then you personally will be pushed into 40% tax bracket.
Tax savings are at their biggest where the company is making good profits and the directors/ shareholders do not need to take all that money out each year.
There are also general record-keeping rules for companies which do not apply to sole traders and partnerships. While all businesses have a legal obligation to keep business records, limited companies need to hold board meetings and record minutes of decisions made.
Even opening a company bank account will mean the bank asking for the date of the meeting that the decision was taken to open the account.
One of the least understood aspects of companies is the tax effect of setting up more than one. The 21% tax rate I mentioned applies for profits up to £300,000.
If your profits are more than that then your overall tax rate will rise up towards 28%. However if you set up two trading companies then the £300,000 limit is divided by two, no matter what the relative size of each.
Set up three companies and the amount is divided by three. So the lowest corporation tax rate would only apply if profits were under just £100,000.
This is something to consider, because it can raise your tax bills, especially if you have one very profitable company and one or two making low profits. Do not set up more than one company without carefully considering the tax effects.
Trading through a limited company can bring valuable protection, and sometimes tax savings. It is not, however, something you should set up without first taking advice from an accountant.
Adrian Huston, a former tax inspector, is a director of Belfast tax and accountancy firm Huston & Co — www.hustontax.com or (028) 9080-6080