According to Companies House, a limited company is a business structure that has been incorporated with them as a legal ‘person’. This means it is separate from its owners, can enter into contracts in its own name and is responsible for its own actions, liabilities and finances. Owners of a limited company are protected by ‘limited liability’ status, meaning they are responsible for business debts only to the value of either their investment share, or their guarantee value to the company.
A limited company has to be officially registered with Companies House, which is the official UK registrar of companies. Your company can be either ‘limited by shares’ or ‘limited by guarantee’. Limited by shares companies are owned by one or more shareholders and can be managed by one or more directors. Companies that are limited by guarantee are owned by one or more guarantors and managed by one or more directors. In both cases, the same person can be the owner and director, so you can set up your company and just be its director or bring in other people if you want.
What is a company limited by shares?
The option for a company limited by shares is the most popular type of limited company in the UK. The idea is that you set up a company that is a profit-making business and you can keep surplus income for yourself. With a company limited by shares, you can set it up for just yourself alone, or with other people, and each shareholder has personal financial protection due to limited liability.
Basics of limited by shares:
- The company is a separate legal entity responsible for its own income, assets, liabilities and debts
- It is the most common company type for small and medium businesses
- The company is owned by shareholders who buy shares in the company, investing their money in it and each shareholder’s percentage of ownership depends on the number and value of the shares
- Financial liability for shareholders is limited to number and value of those shares so if the company cannot pay its bills, shareholders are only asked to pay the nominal value of those shares
- Profits are distributed based on how much of the company shareholders own and are issued as dividend payments although it is common to reinvest a percentage of profits into the company
- Shareholders appoint directors who manage the daily operation of the company for them and sometimes they themselves are the directors
Why form a company limited by shares?
There are four main reasons to consider this type of company formation for your business:
1. You want to start a money-making business for yourself and partners if you have them
2. You want a company structure that will let you sell a percentage of the company to others
3. You are not personally liable for company debts as a shareholder, only for what you agree to pay for your shares
4. The structure creates a professional image and improves credibility as many people prefer to deal with limited companies versus sole traders
What is a company limited by guarantee?
Basics of a company limited by guarantee:
- The company is a separate legal entity with responsibility for its own income, assets, liabilities and debts
- There are no shareholders and no shares are issued but instead have people who are called guarantors
- The personal liability for a guarantor is fixed and is called a guarantee and this is what they would have to pay if the company cannot afford to pay its debts
- Guarantors appoint directors to handle the daily running of the company and it is common for them to take the role themselves
Why form a company limited by guarantee?
There are four main reasons to consider this type of company formation:
1. You are planning a non-profit company such as a social enterprise, sports club or cooperative
2. Profits will be used for the business to achieve its goals, promote its aims and not to make a financial gain for guarantors
3. Personal liability is limited by the guarantee and this is the total amount they would need to pay if the company couldn’t afford its debts
4. The structure creates a professional image and improves credibility as there is often a preference for dealing with limited companies rather than sole traders
What is a limited liability?
One of the main principles of the limited company is called ‘limited liability’ and this is the extent of financial responsibility for a shareholder or guarantor if the company has debts or financial problems. This means you are not liable for more than this set amount.
If someone sues a limited company or it cannot pay its bills, each shareholder or guarantor will only lose the nominal value of the shares or the amount in their guarantee. Limited liability is one of the top reasons for running a limited company or an LLP.
Liability of shareholders
For a company to be limited, it needs to issue at least one share but there is no upper limit to the number. Shares are owned by shareholders and the amount due for each share is the limit of their liability to the company.
Say a company issues 100 shares worth £1 each and has 10 shareholders who each buy 10 shares. The most that each shareholder would need to pay towards the debt would be £10 and the combined liability of all of the shareholders is £100.
Liability of guarantors
If you choose a company limited by guarantee, then each guarantor agrees to pay a fixed amount to any company debts if this is needed. This is the guarantee and for many companies, this is set at £1 so each guarantor would pay £1 towards any debts.
Liability of LLP members
With an LLP, there are no shares or shareholders but members or partners who are liable for the amount they invest into the partnership. Sometimes they may also offer financial guarantees which they would pay if the company ran into financial problems.
Comparing with other structures
Unincorporated businesses such as sole traders and traditional partnerships have unlimited liability on their owners. This is because there is legally no difference between the individual and the company. And all business debts, therefore, become the debts of the owner or partners. If a sole trader is sued and their business becomes insolvent, personal finances and assets like their home or car are at risk.
Advantages of being a limited company
While limited liability is definitely one of the big benefits of being a limited company, there are other benefits including:
- Tax efficiency
- Creates a professional image with enhanced credibility
- Creates opportunities to raise capital
- Can be set up with one or more people
- Perpetual succession
- Protection of the company name
There are some downsides to consider:
- There are extra reporting and filing requirements
- The system for tax and accounting can be more complicated
- There may be higher administration and accountancy costs
- Company information is placed on a public record including director’s, owner’s and people with significant control’s details
Tax benefits from being limited
The limited company structure is a very tax efficient one once your taxable income reaches £20,000. This is because limited companies pay a flat rate of 19% (dropping to 18% in 2020) in corporation tax on the profits that they make. Directors can also reduce their personal tax and National Insurance contributions by paying a mixture of salary and dividends. Directors are also able to defer tax by leaving surplus income in the bank account of the business and taking it out in a later tax year.
For sole traders the tax system is different. Income tax is charged from 20-45% depending on how much they earn and there is both Class 2 and Class 4 national insurance to pay. Sole traders cannot minimise their tax or NI liabilities or defer tax in any way. So tax efficiency is a top reason for people setting up a limited company.
Corporation tax versus income tax
As a limited company, you will currently pay 19% corporate tax on all taxable income. As a sole trader, you will pay 20% income tax on profits above your tax-free allowance (which is currently around £11,500), 40% on profits over £45,000 and 45% on profits over £150,000.
With a limited company, you are able to minimise income tax and national insurance by taking part of your remuneration as a salary then the rest as dividends. There are various ways to pay yourself including:
A director’s salary up to the primary threshold for national insurance Class 1, currently £8,164. No income tax is applied at this level, so you will only pay NI on earnings above that £8.164 amount
Top up your salary with dividends which can only be issued from available profits but can be issued frequently or in a lump sum at the end of the tax year. The first £2,000 of dividends is tax-free and then you pay dividend tax on amounts above this but no income tax or NI because the company has already paid this.
In this example, you would pay Employer’s Class 1 NI through PAYE on your salary as a director. But salaries and NI are tax-deductible expenses, so you wouldn’t pay corporation tax on this money. If done carefully and correctly, you can reduce your income tax and NI liabilities paying yourself in this way, an option not available to sole traders.
Leaving surplus cash
As a limited company, you are able to leave some surplus income as a profit and loss reserve to be used at a later date or withdrawn. This can help if taking all of the profit would cause you to move up to a higher tax rate. If you don’t need all of the funds, then you can even defer some personal tax by withdrawing this in a future tax year if it is more tax efficient to do this.
There’s no way to do this as a sole trader because there’s no difference in business income and personal income. So tax and NI have to be paid on the profit in that tax year regardless if the profit is taken or left in the business.
How to register a limited company
Your Company Formations offer a range of online company formation packages for limited companies. These include packages for companies limited by shares and by guarantee and have a simple process to follow.
You can choose a company name (use our company name checker to make sure it’s free to use), purchase a formation package, complete the online form and submit the application. We can handle everything for you and will register your new company with Companies House on your behalf. With our expertise and many years of experience with company formations, we can make sure that the whole process is handled correctly from start to finish and takes the pressure off your shoulders about getting your official registration right.
Our formations procedures are swift and we can usually get your new company off the ground within 24 working hours and you will receive your documents to allow you to start trading as soon as you like.
If you have any more questions about forming your own limited company, do not hesitate to contact us – we are here and ready to help!
Further reading: Limited Company Advantages and Disadvantages