VIDEO TRANSCRIPT:

Hi this is Nick. Welcome to Quest. This is part two of three videos comparing whether or not you should set up as a sole trader or a limited company.

Today we talk about a limited company, so let me just say right off the bat if your primary concern is risk, if you’re worried about the risks you’re taking in terms of setting up a new business, then go limited because what a limited company is, as the name suggests, gives you limited liability.

So long as you don’t act recklessly or fraudulently or stupidly, then should the company fail, then any debts it’s incurred rest with the company that can’t come after you personally.

If you’ve acted inappropriately then they can, but as long as you don’t run up debts that you can’t afford to pay, you don’t borrow money then go gambling with it, you don’t do stupid things, you don’t do reckless things and you act honestly, decently and try and conduct yourself in the right manner, then the liability stays with the company.

Okay so that’s maybe for you the prime reason for starting a limited company, but if we’re looking at the difference in tax regimes, then theirs how the taxes on a limited company work.

Now, I’m going to break this into two sections okay, because you’ve got to get your head around the idea that once you set up a limited company there is the limited company, that is one legal entity, and then there’s you and you are now separate legal entities, even if you own the company.

So the company, up to three hundred grand will pay nineteen percent of its profits in tax. That starts straight away, so if its profits for the year are a pound, it’ll pay nineteen pence.

That carries on straight through and you may think ‘okay, that’s nice and simple’ We’re just getting started because the thing you’ve got to do then is you’ve got to get the money out of the company and there’s really only two ways in which you can take money out of a company: You can a put it through payroll. To set up the payroll system put yourself on as an employee and pay yourself that way or because you’re the shareholder you can also take out dividends.

If you put yourself on as an employee, then typically what I would suggest is take that up to £8146 per year. Right, funny number I know, but it’s to do with national insurance thresholds. Below that figure, you won’t pay any tax or national insurance either.

After that figure, if it’s just you in the company where you’ll start paying two types of national insurance. You pay employees national insurance at 12% and employers national insurance at 13.8%.

So in other words you’re paying 25.8% percent in national insurance and because that’s higher than the rate of corporation tax, then it’s not worth doing.

So if it’s just you, payroll up to £8164. If there’s somebody else on the payroll with you, you get an exemption on the employers national insurance for the first £3000.

So in that situation what we normally suggest to people is in that case, put yourself on payroll and take your income up to £11500 a year because that’s the rate at which income tax kicks in. Well, that’s the threshold I should say and then beyond that, you’re paying income tax at 20%, within the basic rate band, which is higher than corporation tax, so not worth doing.

And this reference to corporation taxes, that the reason it’s relevant is because anything that goes through payroll gets deducted from your profits of the company, which in turn brings you your corporation tax bill down.

Okay, so if it goes through payroll, it brings corporation tax down. If it goes through dividends, if you pay yourself through dividends, it doesn’t and therefore we try and make the most of the fact that most people have a personal allowance so it’s to minimize corporation tax.

So let’s say you’ve paid yourself up to £8146 and then you go ‘Right, I’m going to take the rest in dividends. How does that work?’ Well, yes if you’re the shareholder you can take dividends out and as things stand you can take out £5000 worth of dividends you won’t get taxed. That’s going to come down to £2500 next year.

But after that £5000, you’ll then going to start paying 7.5% on your dividends. That will get dealt with as part of your self-assessment every year, so as soon as you start paying yourself dividends you have to do it as a self-assessment and need to be paying the tax if there is any on that.

So as I say, we’re going to do another video which actually compares the two and goes through sole trader versus limited company, but this is about how a limited company works.

Oh one last thing I nearly forgot, in terms of when you pay tax for a limited company, if I set up a company today on the 12th October, in twelve months time my company would have its first-year end, nine months after then I’ve got to submit my accounts and I’ve got to submit my corporation tax return and pay it at that time. So that’s the timeframe.

Thanks for listening. I hope this has helped you.

If you liked this blog post: Sole Trader vs Limited Company, then make sure to check out our last one: Tax Treatment of the Directors Loan Account.