Set Up a Limited Company to Save Tax?

The Telegraph has a guide to setting up a limited company, and how much tax it could save you.

Running your own company can have significant tax benefits compared to being a sole trader. However, with these benefits come additional responsibilities as a business owner. This article will guide you through the process of setting up your own company and highlight the potential tax savings you could make.

Difference between sole traders and limited companies:
Currently, there are approximately 4.3 million self-employed people in the UK, operating as either sole traders or limited companies. The main difference between the two is liability. Sole traders are personally liable for all debts and obligations of their business, meaning personal assets may be at risk in the event of financial difficulties. Limited companies, on the other hand, limit the liability of shareholders to the amount they have invested in the company.

Setting up as a sole trader:
Setting up as a sole trader is relatively simple. If you have never paid tax through self-assessment before, you will need to register with HM Revenue and Customs (HMRC) by setting up a Government Gateway account. This will enable you to file your tax return and pay any income tax or National Insurance contributions owed each year. While being a sole trader is a straightforward option, it also means taking on all the risks and personal liability for debts. Additionally, some sole traders may find it challenging to establish credibility and reputation compared to a limited company, which could affect their ability to sell products or services.

Setting up a limited company:
If you choose to trade through a limited company, there will be more paperwork involved. To establish your business, you need to complete an incorporation form and submit it to Companies House. This form includes details such as your company name, registered office address, and initial directors and shareholders. The cost for this process is £12, and you can either do it yourself through the Companies House website or seek assistance from an accountant. Furthermore, it is crucial to have a separate business bank account to keep personal and company income separate. You can open an account online or in a branch, considering factors such as fees, additional services, and savings or credit rates. It is also beneficial to have an accountant and bookkeeping software to manage end-of-year compliance tasks and keep track of finances.

How your company choice affects your tax bill:
Taxation is a significant differentiating factor between operating as a sole trader and as a limited company. Sole traders are subject to individual income tax rates, ranging from 20% to 45%, depending on earnings. They can deduct work-related expenses to reduce the tax payable. Additionally, sole traders need to pay Class 2 and Class 4 National Insurance contributions. In contrast, operating as a limited company can be more tax-efficient. Instead of being taxed on earnings, the company pays corporation tax on profits. As the director of a limited company, you will need to manage both corporation tax and income tax on the salary you withdraw. Taxes on dividends, which can be a part of your income, are also applicable, subject to different rates. By structuring your income wisely, you can potentially reduce your overall tax bill.

Tax savings for limited company directors:
Analysis by Mazars, an accountancy firm, reveals that limited company directors can make significant tax savings compared to sole traders. For example, if a sole trader earns £30,000, they would be left with £24,766 after income tax and National Insurance deductions. However, a limited company director could take a £12,570 salary, up to the personal allowance and employees National Insurance threshold, and receive the rest as dividends. By doing so, they would pay no income tax and only be subject to employers National Insurance contributions, corporation tax, and dividend tax, leaving them with £25,187 – an additional £421. Furthermore, as directors, there are additional tax-saving opportunities such as deducting certain expenses from the corporation tax bill. It is essential to consult with professionals to weigh the potential savings against the costs and responsibilities of running a company before making a decision.

Setting up your own company can provide substantial tax benefits compared to being a sole trader. However, being a limited company director comes with additional responsibilities and administrative tasks. Therefore, before making a decision, consider factors such as the nature of your business, potential liabilities, long-term goals, and personal preferences. Consulting with legal and financial professionals can provide guidance and ensure you make an informed choice.