When talking to clients who run their own company or delivering presentations on the differences between acting as a sole trader (or partnership) or as a Limited company, one of the most important points to get across is that a Limited company is a separate legal entity to you as an individual.
What’s mine is my own
As a Limited company, the bank account isn’t yours; the assets aren’t yours. You are an employee (probably Director) and shareholder of that separate entity.
On too many occasions, I’ve seen people get into trouble because they treat a Limited company like their own personal bank account, much like they’d been able to do while undertaking business as a sole trader.
Just to remind you, as a sole trader, you’re taxed on the income you earn as a business, regardless of whether you require the funds or actually spend them. Although this can be tax inefficient if you don’t require the funds, it does at least mean that what is in your bank account is yours (subject to making sure you have enough to cover your tax liabilities).
However, when operating as a Limited company, the company pays tax on its profits and the individual is taxable on the income they extract from the company (eg by salary or dividends) and, so the individual should make sure that they only extract funds that are intended to be their taxable income or to be repaid to the company.
Payroll and Paperwork
On top of the Companies House and HMRC filing requirements of running a Limited company, there are also the requirements of running a payroll and completing paperwork such as dividend vouchers to keep on top of.
As a Limited company, you are likely to be extracting profits via salary and dividends. In order to pay salary, some form of payroll software will be required that allows Real Time Information (RTI) to be sent to HMRC and provides you with a payslip each month, along with a P60. A payroll system will also allow to you collect tax on benefits (which will be discussed later) via PAYE codes.
When declaring dividends, it’s also important to make sure that paperwork is completed with regards to board minutes and dividend vouchers. In practice, owner managers might be sitting around their dining room table eating tea when dividends are ‘declared’, but the paperwork still needs to be on file to show that a decision was made on a set date to declare dividends and extract remuneration. Not having this paperwork in place could lead to HMRC questions.
They were my assets before!
Another area where people may fall foul is the ‘benefits regime’, which applies to those operating via a Limited company. While conducting business as a sole trader, an individual will use assets such as a car and claim a proportion of those costs against the business. Taking the principle of the company funds above, the individual is trading for themselves as a sole trader and therefore also owns the assets personally.
But when trading as a Limited company, assets such as cars are often acquired (or leased) via the company directly and are then used by the shareholders/Directors. As an employee of a Limited company, you are then subject to the benefits regime and will receive a Benefit in Kind (BIK), which must be reported via a P11d and forms part of your taxable income.
How the Benefit in Kind is calculated depends on the company asset you are making use of personally.; but for example a car BIK is based on a calculation taking into account the list price and the Co2 emissions of the car; the lower the Co2 emissions, the lower the benefit charge.
You can, however, have a mobile phone provided by the company which is free from a BIK charge. Be careful with this; make sure that you don’t take the contract out personally and have the company reimburse you, as this scenario wouldn’t qualify for the tax-free exemption and can actually be subject to both Income Tax and National Insurance.
There are also other Income Tax and National Insurance-free benefits, so be sure to research or ask your advisors what can be claimed.
Dividends are most tax efficient, aren’t they?
As a rule of thumb, the most tax-efficient way of extracting profits from a company is via a NI level salary with the remainder being extracted as dividends. By “NI level salary”, what we mean here is a level of salary, which means that no employee National Insurance arises but, as an individual, you still receive a “stamp” towards your state pension.
The company will also receive a Corporation Tax deduction for the salary paid, unlike dividends which come out of post-tax profits. For the tax year 2022/23, a “NI level salary” of £9,096 is normally recommended for Directors.
However, there are a few further steps to consider if this is right for you as a Limited company:
- Is the company undertaking and claiming Research & Development that may qualify for enhanced relief? If so, it might ultimately be more tax efficient to pay more salary, as salary receives an enhanced deduction, whereas dividends do not.
- Are you over state pension age? If you are over state pension age and are therefore at a point where no employee National Insurance is due, you will want to run some calculations as to whether salary becomes more efficient than dividends.
- Ever changing rates! As rates of tax change for both Income Tax, National Insurance and Corporation Tax, it’s always worth taking advice or running calculations to check is most tax efficient for you.
Trivial benefits add up
HMRC allow you to give small benefits (less than £50) to employees free of tax. The gift can’t be cash or and neither can they be a reward for service or performance.
Generously, HMRC also allow a Director to receive up to six lots of £50 gifts from their company each year with no tax implications.
So, if you can think of six reasons throughout the year (i.e. Birthday, Easter, Christmas, Anniversary etc.), then the company can provide you with up to six gifts throughout the year completely tax free!
What happens at the end?
What many clients tend not to think about is what is the end goal? How do I bring my business to a conclusion? For a sole trader, it can be relatively straightforward. As all income has been taxed as it is earned, then an individual can ‘walk away’ from the business knowing that what they have earned is theirs.
But as a Limited company, thought needs to be given on how that company may be wound up. Can the company be sold? Is the company going to be passed down to the next generation? Has the company come to an end and how, therefore, are funds going to be extracted – by dividend or liquidation for example?
All of the above scenarios need good planning well in advance, to understand the tax implication and what the best option is for that company and the individuals involved.
The right advisors…!
And that brings me on to my final point… Make sure you have the right advisors in place to give you the most up-to-date and bespoke advice for you and your company/business. Having the right advisors at the right time can help save you tax upfront, down the line and also help you avoid any pitfalls that come with running a company. In the fast-paced world in which we live, what can be sound advice today might not be the same advice in 6-12 months’ time.
These notes are provided as information only and should not be relied upon as advice, or treated as such. No liability is accepted for any errors of fact or opinion they may contain. Professional advice should always be sought before making any decisions. For further information, please get in touch with our Tax Team on 0333 1237171.
