The Pros and Cons of a Limited Company

When it comes to self-employment, there are generally three options on the table – operating as a sole trader, setting up a limited company or joining an umbrella company. In years gone by, the second option was by far the most popular due to its enviable tax efficiency and reduced liability. However, the introduction and expansion of IR35 legislation has affected its standing to no small degree.

Formerly, a self-employed individual could set up a limited company in their name and file all of their tax returns through it, taking advantage of generous tax breaks in the process. However, IR35 was introduced in 1997 to clamp down on contractors who were employees of their end clients in all but name.

In 2017, the rule was amended so that the end client was responsible for determining whether the contractor fell “within” IR35 regulations for all contracts in the public sector, meaning countless self-employed people suddenly became liable for thousands of pounds worth of additional tax. From April 2020, that rule will be expanded once more to include private sector contracts as well, meaning as many as 170,000 more workers will fall within IR35’s dragnet.

Having said that, there are still a number of attractive advantages to setting up a limited company. Pros and cons should play an integral part of the process when taking any major decision in the world of business, so here’s a quick rundown of the various benefits and drawbacks that limited companies hold.

Pros of a limited company

The principal advantages of setting up a limited company include:

• Limited liability. As the name suggests, setting up your own limited company makes the business a separate entity in its own right. This means that should the company run into financial difficulties or be forced to declare bankruptcy, your personal assets will be not be compromised. In fact, you are not compelled to pay anything more than the value of the shares you hold in the company. This distinction between business and personal finances is not applicable to sole traders, meaning they do not enjoy any such protection.
• Tax efficiency. Limited companies are subject to 19% corporation tax, which is far lower than the 20% to 45% that is payable on the income tax of sole traders or employees. While IR35 means that it may be more difficult to prove that your limited company should qualify for this discounted rate, there are other additional tax benefits to setting up a limited company. These include deferring profits to a later tax year, paying yourself in dividends instead of a salary and reinvesting surplus cash back into the business, all of which allow you to pay a reduced percentage of tax.
• By setting up a limited company that is registered with Companies House, you create an aura of professionalism and credibility around your enterprise which will only elevate it in the eyes of potential clientele, investors and business partners. Indeed, some parties may specify that they will only work with limited companies, meaning you may gain access to a whole new pool of customers and partners that was previously closed off. The same is true of attracting investment from banks and private investors.

There are other aspects to consider, such as the ability to copyright your business name and protect it from being adopted by others, as well as enhanced options with how you manage your pension contributions. But the aforementioned factors provide the main impetus for sole traders to set up a limited company.

Cons of a limited company

Having said that, there are many reasons why creating a limited company might not be advantageous to you. Some of these include:

• Increased paperwork. Sole traders need only file their self-assessment tax return each year. Directors of a limited company, on the other hand, need to file accounts, corporation tax return and their own personal tax return, as well as a Confirmation Statement with Companies House. That’s in addition to registering with Companies House in the first place.
• IR35 compliance. Depending on the nature of your clients and the contracts you hold with them, you may be forced to jump through hoops to prove that you fall outside of IR35 regulations. This will involve proving the control you exercise over your work, your ability to send a substitute in your place and the absence of any obligation on the part of your client to provide work or you to accept it.
• Higher tax contributions. Even after investing the time and effort to prove to HMRC that IR35 does not apply to you, there’s no guarantee that they will view things the same way. If they do not, you may be forced to pay a significantly higher rate of tax and national insurance contributions (NICs), thus incurring several thousand pounds in additional expenses.
• Reduced day-to-day control of finances. You won’t enjoy the same freedom with regard to your finances using a business account as you did with a personal one. For example, you’ll be obliged to pay yourself a salary (plus dividends, if applicable), then reimburse yourself for expenses paid from a personal account. This kind of arrangement can quickly become more complicated and confusing.
• Less privacy. When you set up a limited company your Confirmation Statement, along with all annual accounts and your office address, will become information that can be freely requested and obtained by members of the public. This means anyone will be able to see if you are making profits or losses – and, crucially, how much of either.

The umbrella option

An increasingly popular alternative to working as a sole trader or setting up a limited company is contracting an umbrella company. This dispenses with the need for all the above pros and cons of a limited company by joining the payroll of the umbrella company, thus bypassing IR35 legislation altogether and handing over all tax compliance duties to the firm in question.

What’s more, they’ll also endow you with some other benefits that neither of the alternatives offer, such as statutory rights. Since you’ll be deemed an employee in the eyes of HMRC, you’ll be entitled to sick pay, holiday allowance and maternity or paternity leave, all while still retaining the autonomy and freedom of self-employment.

Compare umbrella companies

To investigate how an umbrella company could be the perfect fit for your situation and compare the various options against each other, check out Umbrella Supermarket’s online comparison tool. In a few clicks, you’ll be able to compare quotes from several leading providers.