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This is a news story and may not be up to date. You can find the date it was published above the title. Our Tax Guides feature the latest up-to-date tax information and guidance. 

Published on 22 November 2023

5 questions to ask yourself before setting up a limited company

Whether you are starting a new business or are looking to develop an existing one, you may be considering setting up a limited company. Limited companies are cheap, easy to set up and may have certain benefits. But they can be difficult to run and expensive if things go wrong. You therefore need to think carefully before deciding to set one up!

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We know from the number of people who contact us asking for help with their limited company problems that many people wish they had never got involved with setting up a limited company. Although for some people, it will be the right choice, it is really important that you do your own research on how limited companies work and come to an informed decision yourself.

We have lots of information on our website to help you do that. However to help you form a quick view, we have set out 5 key questions below to ask yourself. If you answer ‘no’ to more than one or two of them, it may be that setting up a limited company is not for you at this time (or you may at least want to take some advice before going ahead!):

  • Has a professional advised me to set up a limited company?
  • Do I like formality/responsibility?
  • Do I understand how to take my money out of the company?
  • Do I have access to ongoing accountancy/tax support?
  • If I’m on universal credit, do I understand the potential complexities? 

Has a professional advised me to set up a limited company?

Over the years, we have seen an increasing number of low-income, unrepresented taxpayers getting involved in limited companies. Sometimes this is because a friend or an internet search has suggested that it could help them pay less tax and/or provides them with protection if anything goes wrong. Other times it is because they incorrectly think that to be in business you must trade as a limited company or if you go over the VAT threshold, you need to have a limited company.

However, in reality, the tax benefits are often overstated, and the ‘limited liability’ protection an oversimplification. Also, running a limited company is not the only way of being a business – you can also be a self-employed sole trader, for example, which is generally much more straightforward when starting out or when income is modest (and you can still be a sole trader even if you go over the VAT threshold).

Before setting up a limited company, it is important you understand what it means to run your business as a limited company and whether that is the right thing for you and your business. It can be an expensive mistake if you then have to pay someone to close it down for you and deal with any compliance issues that have cropped up in between. You should therefore take some advice from a professional who has expertise and experience in limited companies, understands your facts and circumstances and can give a rounded view. There will almost certainly be a charge for professional advice.  

Do I like formality/responsibility?

A company is a legal entity in its own right, and must be registered at Companies House. This is a different department to HMRC. A limited company is owned by its shareholders, who have shares in the company. If you have your own limited company, you will be a shareholder.

A company will be run and managed by at least one director. The company is usually contracted to provide certain services to customers and this will probably be done by you, as an employee of your own company. This means that if you work through your own limited company, you will probably be an employee, director and shareholder.

There is a lot of paperwork and admin involved in running a limited company (keep reading for the detail!) and there are additional legal responsibilities of being a company director. The actions of a company director are subject to scrutiny by the courts. For example, as a director of a limited company, you must try to make the company a success using your skills, experience and judgment and follow the company’s rules, shown in its articles of association (the internal rulebook of the company).

You can find more information on director's responsibilities on GOV.UK. Becoming a director is definitely not something to be undertaken lightly and you may be fined, prosecuted or disqualified from being a company director in future if you do not meet your responsibilities. 

Do I understand how to take my money out of the company? 

If you are a self-employed sole trader, all the income from providing your services is your own income. However if you work as an employee of your own company, invoices for your services will be issued by the limited company, not you. Money coming in will belong to the company rather than you and should be paid into the company’s bank account and not your personal bank account.

So how do you take money out from your company?

As stated above, you will generally work as an employee for your limited company. As an employee, the company will probably pay you a small salary (to make use of the tax and National Insurance thresholds). The limited company will usually need to register as an employer with HMRC and take income tax and NIC from your salary under the PAYE system depending on the level of salary paid.

The limited company profits, that is the remainder of the money paid to the company (after deducting your salary, any other business expenses such as travel, telephone etc. and also the corporation tax due, if any), will probably be paid out to you as a dividend. A dividend is an income payment a company can make to its shareholders if it has made a profit. If a dividend is not paid out, then the money can be used to grow the business.

There are formalities to observe when paying out a dividend (or taking money out in other ways from your company).

It is really important that you appreciate the separate legal status of the company and are able to differentiate between the company and your own personal affairs. 

Do I have access to ongoing accountancy/tax support?

Each year, your company will need to do various things as set out on our website, like file documents with Companies House and HMRC. As a director/shareholder, you will probably need to prepare a Self Assessment tax return in your personal capacity each year, for example to report dividends.

As stated above, to the extent that you get a salary from your limited company, this should be paid via the Pay As You Earn (PAYE) system. You will also need to keep an eye on the level of the limited company’s business income and regularly check to see whether the company needs to register for VAT, as the VAT regime applies to all businesses including companies.

Taking all of this together, and especially given there can be severe penalties for getting things wrong, in reality, there is probably no substitute for obtaining a tax professional’s advice and assistance. This will usually be an accountant or tax adviser. For more information on finding a paid adviser, see our website.

Please be aware that some people call themselves ‘accountants’ but they may not actually have any professional qualifications. It is vital that you take care when choosing an accountant as we have occasionally heard of some poor practices, for example, failure to respond to contact, failure to produce accurate accounts/tax/VAT returns, failure to submit accounts/tax/VAT returns to the appropriate authorities on time or at all, not returning paperwork, acting in conflict of interest, and failing to maintain confidentiality. All of these things can mean a relationship can quickly break down and you are left without any support.

It is therefore important to use a member of a professional body if at all possible as they should work to high ethical and professional standards, and if they do not, you can make a complaint to the professional body. Unfortunately, there will be costs involved in getting a good adviser and this can substantially reduce any financial benefit of trading as a limited company in some cases.

You should therefore make sure that you understand the basis on which fees will be calculated and what they will cover. In particular, make sure you understand if there are penalties if you sign up to pay for a ‘package’ of services on an ongoing basis, but want to leave early.

Please note that the charity TaxAid, who usually help low income taxpayers with tax problems, does not currently have the resource or capacity to help with limited company issues. 

If I’m on universal credit, do I understand the potential complexities?

If you are on benefits and are thinking of setting up a limited company, it is very important to understand how running a limited company may be treated for benefit purposes. Before we explain the situation, it is worth emphasising that in some cases, due to the administrative requirements, a company will not be a suitable way for those with modest incomes to trade.

Universal credit (UC) is gradually replacing working tax credit as the primary welfare support for low-income working-age people. The Department for Work and Pensions (DWP) pays universal credit, and the DWP are different to HMRC. Under the universal credit rules, there are special rules for certain company directors. If these rules apply, the limited company structure is effectively ignored and the director treated as self-employed. We explain more on our specialist website Revenuebenefits.

This means any income/receipts of the company is treated as self-employed income and any allowable expenses of the company are treated as self-employed expenses. Self-employed earnings are then calculated as: self-employed income minus allowable expenses minus deductions for income tax, NIC and certain pension contributions. You can find guidance on how to report your income and expenses on GOV.UK.

While the basic framework is in place, because of the relatively small numbers of director claimants involved, the detail isn’t yet clear and there is a lack of official guidance. We also understand that there may be some misunderstanding about how the rules work in practice for directors amongst UC staff, and this can result in some confusion or uncertainty if you are being told different things by different people.

Having to deal with different sets of rules to calculate and report income and expenses for tax and UC may be complicated, frustrating and stressful. In addition, because directors are treated as self-employed, they can be affected by the minimum income floor (MIF) in universal credit.

The MIF is usually calculated as 35 hours a week x relevant minimum wage rate, less a deduction for notional tax and national insurance. One impact of the MIF is that if a self-employed claimant earns a low amount in a particular assessment period, for example because they had less work or because they had a large business expense to pay, their universal credit will not increase to reflect their fall in actual income.

While none of these things are complete barriers, if you are on universal credit or may need to claim it in the future, it is important to understand that the situation is not straightforward and a limited company may add another layer of complexity.

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