Owning a Limited Company is traditionally the primary way to lower your tax bill because you can use dividend payments (taxed at a lower rate than income tax) to take out your profits.
Contractors use Limited Companies because they can deal with multiple sources of income and profits are calculated less expenses, meaning that if you incur high expenses (that you can’t reclaim) to fulfil your contract a Limited Company might be more beneficial.
What’s a Limited Company?
A Limited Company is a unique entity much like a person created to undertake some form of trading. It’s legally responsible for its own actions and those of its workers (hence why it will need insurance cover) and just like a person it can be charged with criminal offences.
Of course no company can make a decision without people at the helm though, as such Limited Companies have “Directors” that decide the direction a Limited Company will take.
Above the directors sit the shareholders. The shareholders own a portion of the business (or all of it if there is just one) and elect/remove directors to ensure the company is managed in their best interests as they do not direct the company themselves.
Whereas the director is liable for the actions they choose, the shareholders are not liable for the company’s actions.
Limited Companies also have a “Company Secretary”, which is a nominated person responsible for filing the company’s accounts, annual return and any other statutory documents.
Because creating accounts is often complex, companies usually retain the services of an accountant to do it for them.
When a contractor creates a Limited Company for themselves to trade through, they will often be the shareholder, director and company secretary.
Why a Limited Company?
Limited Companies come with more paperwork than an umbrella but they have a tax advantage too.
If you’re contracting now, but want to take on additional work, employees, or grow your business through investment in equipment, then a Limited Company will be a better option than umbrella because it offers flexibility and tax benefits for large expenses.
With an umbrella you will have to work under the banner of someone else, whereas through your own Limited Company you can have your own company name, brand and even a title like “Managing Director”.
Downsides to a Limited Company?
With running your own business comes more responsibility.
You’ll be classed as self-employed, meaning you’ll need to fill in a self-assessment return each year and potentially hold back tax to pay.
You’ll also have considerable company filings to complete including paying corporation tax, although your accountant should prepare these calculations and returns for you.
There are also little things to consider such as you’ll need to do your own invoicing, source insurance cover and find out whether or not you’re caught by IR35.
While sourcing insurance is straightforward but costly, working out if you’re caught by IR35 rules can be difficult.
IR35 is a set of rules designed to work out if you’re really just a disguised employee of your client and as such should be treated as employed for tax purposes.
