What is a limited company...
(...and how does it work when it is owned and run by one person?)
Includes information about companies run by spouses or other 'household' partnerships
GLOSSARY – you’ll need to understand these terms…
Limited Company – A separate legal entity created (usually) to trade for a profit. It has its own accounts and pays its own tax on the profit.
Incorporation – The process of creating the above.
Limited Liability – The notion that a company is only liable to the extent of its own capital and reserves.
Companies House – The official body that registers companies and holds the public elements of its records.
Accounts – A set of financial statements showing, in essence, the profit (or loss) of the enterprise for the year; the undistributed profit brought forward and a snapshot of the financial position at the end of the year (i.e. bank balances, debtors, creditors, assets and so on).
Abbreviated Accounts – As the name suggests, a short version of the full accounts that small concerns may submit to Companies House as the public record.
HMRC (HM Revenue & Customs) – The tax office, to whom full and detailed accounts, computations and returns must be submitted. Dealings between companies and HMRC are confidential.
Accounting Reference Date (ARD) – The last day of the accounting year.
Shareholder – Someone who has bought shares (i.e. provided capital) with a view to receiving dividends on the investment. Shareholders own the company; they do not run it but they hold The Board to account.
Distribution – Dividends paid to shareholders out of post-tax (‘retained’) profit.
Director – One of the people who run (manage) the concern and who are legally responsible for it. Directors are employees.
The Board – All of the directors. The Board decides on the proportion of the retained profit to be distributed to shareholders.
Confirmation Statement – A relatively simple statement/declaration of the directors, shareholdings, shareholders and other basic information to Companies House. Not to be confused with [annual] accounts.
Corporation Tax – ...paid to HMRC by a company on its own profits.
Tax Computation - The document that adjusts the profit shown on the accounts to the profit 'for tax purposes'. For example; depreciation is not an expense for tax purposes but has an equivalent called Capital Allowances, which are calculated in a different way. Also, there are some expenses that are specifically disallowed for these purposes.
Corporation Tax Return (CT600) - The document that reports the taxable profit to HM Revenue and Customs (HMRC). CT600s must be submitted electronically, accompanied by full accounts and the tax computation via a special formatting system called iXBRL, for which specific software is required.
Extractions – A general term for money taken out of a one- or two-person limited company for those persons’ personal income; it doesn’t have an official meaning.
How does a one-person company work?
The same person is the sole director and the sole shareholder. A director takes a salary as an employee and a shareholder gets dividends out of post-tax profit.
The Board decides on salaries and dividends so, to the fullest extent permitted in law, a one-person business has complete freedom to allocate extractions as he or she sees fit.
The director is also, by definition, the person who actually does the work and generates the income. In that way, it may ‘feel’ like a self-employment (sole trade) and the day-to-day activity may be no different, but the worker and the company are financially separate and that’s where the director needs to act accordingly – and where it differs from a sole trade.
For the large majority of such concerns, to a greater or lesser extent their accountant acts in loco directoris to ensure the principal legal aspects are handled, allowing the person to get on with their work.
Many companies are formed by spouses or other co-habiting partnerships, because ‘household’ taxation can be minimised through different levels of salary and dividends between them.
The main responsibilities of The Board
1. To keep adequate day-to-day financial records, i.e. bookkeeping (although in reality, this may be no more than a monthly update for one-person ventures).
2. To ensure the company remains solvent and there is no risk to customers or creditors (this follows from 1 above).
3. To observe relevant laws such as health and safety and to maintain suitable insurance.
4. To act in the best financial interests of the company.
5. To arrange for the preparation of annual accounts and tax computations, and for them to be filed on time.
6. To arrange for the preparation of the Annual Return, and for it to be filed on time.
7. To account for all payroll taxes, National Insurance, Corporation Tax [and VAT, if applicable] and to ensure they are paid on time.
Accountants can potentially handle all of these except for item 3, and most usually handle 5, 6 and 7.
The main responsibilities of the shareholders
There are no real legal responsibilities but clearly in bigger enterprises they hold The Board to account and have the power to demand the removal of directors or even the whole Board. They may also demand that a company is run in a different way but of course this would require a majority vote. This is obviously irrelevant in a one person or ‘household’ venture.
A word about Limited Liability
Whilst a company is technically only liable up to the value of its net assets, this doesn’t protect directors from being pursued for negligent behaviour or actions. Negligence might include failure in respect of responsibility 2 above. Indeed, in a one-person venture it is almost bound to be negligence that leads to insolvency. It is essential to obtain proper professional insurance and to take financial responsibilities seriously.
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Advantages and Disadvantages
This is too big a subject to go into here and is something for discussion at the free initial consultation, but here are the two factors that end up being the bottom line for many people:
1. It will generally cost more in accountancy fees and general administrative costs and time to run a limited company than the equivalent sole trade - although much depends on the arrangements for item 1 under the ‘Board’s responsibilities’ paragraph above.
2. In principle, tax and NI can be saved compared with sole trade or partnership in any business where the profit is over about £8,000 per participator.
Under the new rules for taxing dividends introduced in April 2016, the advantage under 2 above is now significantly curtailed. For at least ten years previously, successive chancellors had created a tax and NI landscape that favoured incorporation ever more strongly. Effectively, we have come full circle and the tax/NI advantage only starts to tip the balance at profit levels that would otherwise put a self employed trader into higher-rate tax.
Why does it cost more in accountancy and administration?
The answer is summed up best by Roger H Jones FTII TEP in his highly-regarded book 'Incorporating a Business', Third Edition (Tottel Publishing ISBN 978 1 84766 131 9):
“Companies are far more strictly regimented than unincorporated businesses. The business needs to be of sufficient size to have in place the requisite administrative systems to cope, or else continuing professional assistance will be required.”
How do I calculate the potential tax advantages?
This is now even more complicated than previously! We are happy to provide a FREE overview so just send us an email.