1. What is a limited company?
A limited company is owned by its shareholders, who are allocated a percentage of shares in the business. The term “limited” refers to the fact that the company’s finances are separate from the personal finances of the owners. Shareholders have ‘limited liability’ which means they are liable only for the amount that they have invested in the company and are not personally responsible for company debts. However, they may be asked to give a director’s guarantee in order to obtain company finance from a bank or other lender, in which case they may be personally liable for that debt.
As a limited company there are a number of requirements that have to be fulfilled:
- The Company must be registered at Companies House.
- Annual Accounts and an Annual Return must be filed at Companies House each year.
- A return of the Companies Profits must be made to HMRC each year.
- Any resulting Corporation Tax must be paid to HMRC within nine months of the Company year end.
- PAYE must be operated for anyone employed by the Company, and the company must pay any income tax and national insurance due to HMRC each month.
2. How do I set up a limited company?
Most accountants will form a limited company for you; however for those contractors who intend to set up their own Limited Company, we have included the following basic guide outlining the requirements for registering your company.
Registering your Limited Company.
Before your business can set up as a limited company (or become “incorporated”) it needs to be registered with Companies House.
You will need to complete the following documents and return them to Companies House to complete the incorporation process:
- Memorandum of Association – includes information on Company Name, Location and Type of Business.
- Articles of Association – These outlines the powers of the Directors and the rights of the shareholders, etc
- Form 10 – Provides details of the Directors’ and Company Secretary’s Names and Addresses, together with the Registered Company address,
- Form 12 – Simply states that the Company complies with the terms of the Companies Act.
These documents are normally prepared by accountants or formation agents; however there is no legal requirement to use either. Guidance on all aspects of the registration process, including documentation required to complete the registration process can be found at the Companies House website.
3. How do I pay myself through a limited company?
The way in which you pay yourself through a limited company depends on the of the individual contract you are working on. A good accountant who is knowledgeable of the contracting / freelancing market should be able to arrange an IR35 review of your contract.
What if your contract is outside IR35…?
If your contract is outside IR35 then the most tax efficient way to pay yourself will be to take the traditional route of a low salary (subject to income tax and national insurance) combined with high dividends which are not subject to national insurance)
As dividends are provided with a “tax credit” there is no additional tax to pay unless your total income (salary + dividends + interest etc) exceeds the basic rate threshold.
What are dividends?
Dividends are a distribution of the company’s ‘after-tax profits’ to the shareholders of a limited company. Any limited company which has generated profits can pay a dividend to its shareholders. Any dividend paid from a company that is not profitable will be deemed illegal.
After tax profits = Total income / revenue – Expenses (includes your minimal salary) – Company Taxes.
By taking a minimal salary each month you will ensure that the company generates after tax profits (as your income will be greater than your outgoings), at which point you can then pay yourself a dividend.
It is necessary to complete a dividend declaration form each time a dividend is declared.
What if your contract is inside IR35…?
Unfortunately, if your contract is caught by IR35 then all income, less a 5% deduction to allow for expenses, will be subject to tax and national insurance.
PAYE is “pay as you earn” income tax that has to be deducted from your salary before it is paid to you. As part of your accountancy service your accountant will be able to register your company for PAYE and undertake all the necessary administration for you, such as keeping payroll records, advising you of your PAYE and national insurance liability each month, and submitting all year end forms to HMRC.
4. Claiming Expenses through your Limited Company?
The expenses you are allowed to claim through your Limited Company are dependent on the IR35 status of your contract.
Provided your contract is outside IR35 then the following expenses can be claimed:
- Your gross salary – this would usually be kept low, in order to maximise the dividends that you can distribute to yourself as shareholder (thereby avoiding employees and employers national insurance contributions).
- Spouse’s salary (which must be actually paid to them and not be unrealistic, having regard to the duties performed). If your spouse is already employed and earning £40,000 or more, there is unlikely to be any tax saving in paying them.
- Travel expenses(provided you have not been at your client site for more than 2 years)
- Car mileage (provided you have not been at your client site for more than 2 years)
- Accommodation and subsistence (provided you have not been at your client site for more than 2 years)
- Telephone – business calls only.
- Books, magazines, subscriptions and courses – where related to business and your contract work.
- Bank charges and interest – on your company bank account.
- Pension scheme – where paid by the company to a HMRC approved scheme.
- Business insurances, business contents and other business related insurances.
- Computer costs.
- Accountancy fees.
- Business related stationery and postage costs.
All of the above expenses should be supported by a valid receipt or document, with the exception of salary and car mileage.
However, if your contract is caught by IR35 then you can only claim expenses incurred wholly, exclusively and necessarily in the performance of your contract work together with a 5% “administration allowance”. These are as follows:
- 5% administration allowance (5% of gross fees received)
- Certain travel expenses
- Certain accommodation expenses
- Pension contributions
- Approved professional subscriptions
5. Do I need to be registered for Value Added Tax (VAT)?
Value Added Tax (VAT)
Value added tax (VAT) is a tax on consumer expenditure. It is collected on business transactions, imports and acquisitions, and is administered by H.M. Revenue & Customs.
If your company’s taxable supplies (the supply of any goods and services which are subject to VAT at any rate) are likely to exceed £68,000 in the next 12 months then you will need to register for VAT. Once your company is Vat registered you will need to charge VAT on your invoices at the standard rate of 17.5%. Until then you can simply raise sales invoices without adding VAT.
What are the benefits of VAT registration?
Once your company is registered you will be able to recover any VAT that you incur on items that you buy for the business. You can usually claim VAT on the following:
- Computer equipment and software
- Accountancy fees
- Legal fees
- Petrol and motor repairs (if claiming a mileage allowance the VAT element is 1p a mile)
- 50% of the VAT paid on either the car lease rental payments or car contract hire payments.
What are the disadvantages of VAT registration?
The drawback to being VAT registered is that you are required to complete quarterly VAT returns and submit them to H.M. Customs & Excise. Most companies will employ an accountant to complete their VAT returns.
VAT – A few things to remember…
VAT payable must be paid by the last day of the month following the VAT quarter. Failure to pay on time can result in penalties and is likely to increase the chances of your company being selected for a VAT inspection.
IMPORTANT: In order to recover VAT on items that you buy for the business you need to obtain a “VAT invoice”, which shows the suppliers VAT number. Remember to always ask for a VAT invoice as these are not normally provided as standard.
6. Limited Company and Corporation Tax
Corporation tax is tax on your company’s taxable income or profits. For small companies with annual profits not exceeding £300,000, the rate of corporation tax is 20% (this is called the small companies rate). Any companies with profits in excess of £300,000 will be liable at 30%, subject to marginal rate relief.
Companies are required to work out their own corporation tax and are required to deliver a corporation tax return by the statutory filing date, normally 12 months after the end of the accounting period. Failure to do so can result in the company receiving a penalty.
7. Timesheets and Invoices
Most contractors will need to record their time on a timesheet so that their agency or client can approve the hours / days they have worked in a certain billing period. In addition, you will need to ensure that an invoice is raised and submitted to your agency / client for your time.
Many companies now provide online timesheet systems where you can login and record your hours electronically.
8. Choosing your accountant…
As a contractor there are a few options available to you in running your limited company.
You can choose to:
- Appoint an accountant with experience in the contracting / freelancing industry,
- Appoint a smaller local accountant to deal with your requirements, or
- Look after the administration and accounting requirements (specified in section 1) yourself.
Most contractors choose to appoint an accountant, but this choice really depends on how much time (and accountancy knowledge) they have to look after the administration and accountancy side of their business.
Should you decide to appoint an accountant, we would advise choosing one that has experience in the contracting / freelancing industry, as the complexities of contracting legislation like IR35 can bring serious pitfalls.
Hopefully this brief guide has given you an insight into what is involved in contracting through a limited company.