Although this is a question people often ask accountants, there isn't one answer which can be applied across the board. Every situation is different and it would be unrealistic to expect to find advice which doesn't have some exceptions. However we have put together some information about the process involved with setting up a limited company to help you decide if this is the right option for you.

Some of the main factors which will affect your decision may include:

  • What kind of business you are running
  • Your plans for the future of your business
  • Any financial risks involved in running the business
  • Whether or not you have any admin support
  • How important customer perception is to your business

Of course there is always personal preference to be taken into account as well, and it is important that you take the decision you feel most comfortable with. However, it is important that it is a well-informed decision, so here are some basics to bear in mind.

There are four options for structuring your business, and these are:

  • Sole trader – where an individual trades on their own
  • Partnership – where two or more companies or individuals trade together
  • Limited liability partnership
  • Limited company

What is a limited company?

The main legal distinction between a limited company and a sole trader is the fact that the business and the owner are considered separate entities. This means that the directors and shareholders have limited liability, which is where the term comes from.

As a sole trader, your personal assets such as your house, car and anything else that you might have, could all be at risk if you company fails. With a limited company, you have a degree of protection, assuming that you are running the business legally and according to the terms set out in the Companies Act, then your private possessions will be safe from creditors.

This may make it seem as though trading as a limited company is always a good idea, but there are some other things to consider when making the decision. We have been helping people organise their businesses for years and so we have an idea of the kinds of questions that people have when they are considering ‘going limited’, and we have listed some of the most common questions below.

Will I earn more money if I operate as a limited company?

For most businesses which are turning a profit of more than £25,000 per year, you are likely to benefit financially from running a limited company. However, even if you earn less than this, you could still save money by talking to an accountant about how to make your company more tax efficient. Take a look at our Take Home Pay Calculator, which will give you an idea of how much you could be earning as a limited company.

have a burning tax question

Will it be easier to get a loan or a mortgage as the director of a limited company?

There are lenders who will look at mortgage or loan applications from a company director in a more favourable light, but that doesn't mean that you will not be able to secure a loan as a sole trader. Asking someone who specialises in finance to help you find a suitable product is the best idea whether you are a limited company or not.

How complicated is the paperwork and what exactly is involved?

Trading as a limited company usually involves around 15 minutes’ worth of paperwork a month. This includes: completing and submitting your annual accounts to Companies House annually; completing and submitting an annual return with the details of all directors and shareholders; completing and submitting tax returns for both corporation tax for the business and income tax as an individual; and paying the bills for both.

There is nothing too complicated or time-consuming about the administration involved in keeping the relevant records up to date in order to comply with the relevant regulations. However, for someone who isn’t an expert in the relevant tax legislation, it can be easy to overlook areas where you could potentially be making savings. You might be unaware of the options for paying VAT, for example, or how you could arrange to take money out of the business in the most tax efficient way. Using a specialist accountant will help you to save money in all these areas, and possible more, as well as ensuring that you never miss a deadline for submitting official paperwork or paying your tax bills.

Will I pay less tax as a limited company, or is it about the same as if I were a sole trader?

Small companies will usually pay corporation tax on their profits at a rate of 20%, whereas your personal tax rate will depend on how much your business pays you and how the payments are structured. As a limited company, it is also possible to leave some money as a ‘reserve’ in the company to allow you to save for future growth, to invest in equipment etc.

However, as a sole trader or a partnership, you will pay tax on the amount that you earn regardless of whether you invest some of the profits back into the business. There aren’t many options for structuring your tax in an efficient manner so you will be less able to make savings in that area.

How much can I pay myself and how much should I leave as capital for my business?

Although this decision is entirely yours to make, there are some factors which will affect the advice a professional will give you. You will need to ensure that you pay yourself enough to cover your outgoings, but if the business is earning more than you actually need at any given time, then there is little point taking out more than you need as you will pay more tax on it as personal income than you would as corporation tax. You can pay yourself dividends from the remaining profits, which will not attract National Insurance and will allow you to make some savings on your annual bills.

What other benefits are there to trading as a limited company?

There are plenty of benefits to setting up a limited company, and although the chief one is the fact that your personal assets will not be at risk, there are other reasons to consider it, including:

  • A limited company may appear to be a more professional and trustworthy outfit to potential clients. Some larger companies are not keen to work with any business which isn't limited, so depending on the sector you work in, it could be invaluable.
  • Dealing with the management and administration of a limited company isn't significantly more onerous a task than operating as a sole trader. In almost all cases, this is more than outweighed by the savings that you could make through tax efficiencies, and changes in legislation which could keep your costs down.
  • There is no time limit on when you start trading as a limited company, so registering your company can be an ideal way to protect the name, as it means no other businesses will be able to register the same name as you. This means that if you are intending to form a business in the future, you can register the name to ensure nobody else uses it, or register the name of the business you currently run as a sole trader in order to ensure that you are covered until you do wish to move over to trade as a limited company.
  • If you want to expand your business and offer shares to investors, it is much easier to do so when you are trading as a limited company.
  • If you choose to sell your business, a limited company will be a more attractive proposition to a potential buyer than an outfit that you run as a sole trader.

Can I change my mind and go back to being a sole trader?

If you decide you want to revert your status, it is a simple matter of completing a form to have your business removed from the register of companies at Companies House.

Will I need to be VAT registered to become a limited company?

The rules about registering for VAT are the same for limited companies and sole traders, so you won’t have to register unless you meet the threshold no matter how you choose to trade. However, if you do not meet the turnover requirements for obligatory registration then you can still register for tax reasons and your accountant will be able to talk you through all the options available.

For more information on starting up as contractor, please contact a member of our new business team on telephone number: 01253 362062 or email newbusiness@nixonwilliams.com.