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New contractors are often confused about whether they should go for a sole trader route or set up as a Limited Company. In this article of "Path of Education for New Contractors", we address the following points.
A Limited Company is a separate legal entity responsible for its liabilities, income, accounts and taxes. The number of Limited Companies in the UK is increasing as more and more contractors are choosing this option. As per data from Companies House, nearly 426,500 Limited Companies were registered in the year 2011-12. Let us look at some of the key aspects of a Limited Company.
Director: The Director is usually the founder or founding entrepreneur who is legally responsible for managing a Limited Company. Anyone over 16 can be a Director. Directors' responsibilities include business management and handling accounting, financial, legal and taxation matters.
Share capital: Share capital is the amount invested in the business in exchange of a share of the company. Let's say you are investing £5,000 cash in your business, your share capital will be £5,000.
Issuance of Shares: Every Limited Company should issue shares to its shareholders. There are no rules regarding the number of shares to be issued. If you are the only shareholder with a share capital of £5,000, you can issue either one share of £5,000 or 100 shares of £50. Similarly, if you have three shareholders contributing £15,000 towards capital, you can issue three shares of £5,000 each. If you have any doubts about the number of shares to be issued, you should consult a professional agency.
Shareholders: Shareholders are people who own a share in the company and have certain rights and responsibilities. A Limited Company Director cannot take any major business decisions without the approval of other shareholders. Each Limited Company in the UK should have at least one shareholder, who can be the company Director.
Accounts: A Limited Company has to manage its own set of accounts. However, compared to a sole trader, it has to comply with more stringent accounting requirements. Limited Companies are required to maintain detailed account statements, which need to be submitted to HMRC and Companies House.
Taxes: Taxes are calculated on profits left after deducting expenses from income. A Limited Company has to pay taxes as per the corporation tax rate, which can be less than the personal income tax rate for higher incomes. Also, Directors of a Limited Company can draw profit after tax, as dividends, which has a lower tax rate compared to the income tax rate. However as a Director you are an employee of the company and any salary will be subject to Pay as You Earn (PAYE) and National Insurance Contributions. To save personal income tax, Directors of Limited Companies often pay themselves a salary, which is lower than the personal allowance limit.
National Insurance: Limited Companies are liable to pay National Insurance Contributions. As an employer, a Limited Company has to pay National Insurance under Class 1, which is 13.8% of the salaries and benefits paid to employees. Additionally, the salary drawn by Directors is subject to National Insurance. However, most Directors choose to pay themselves salaries, which are lower than the National Insurance limits. No National Insurance is payable on dividends.
Liabilities: The contractors or the owners of a Limited Company are not liable for the entire company, but only for their stake in the company. So let's say the share capital of a Limited Company is £15,000, and you own shares worth £5,000, your liability is limited to only £5,000.
Company Name: All UK-based Limited Companies should have names ending in 'Limited' or 'Ltd'. It should be noted that in the UK, two Limited Companies cannot have the same name. Many resources are available online for finding an exclusive company name. Detailed rules on naming of Limited Companies can be found on the Companies House website.
Company Address: Every Limited Company needs to have a registered address, which is a formal address for correspondence. The registered address should be a physical address including street name, name of the town, pin code, and not just a P.O. Box number. The registered address can be different from the business' operating address. You should note that the registered address will be visible on the internet to everyone who searches for your company.
Company Secretary: Until April 2008, it was compulsory for every Limited Company to have a company secretary, but now it is optional. Some responsibilities of the company secretary are managing the registered office, managing company meetings, managing company's records, filing the annual returns with the Companies House, and so on. If a company decides not to appoint a company secretary, the Director is responsible for all these activities.
Articles of Association: The document named 'Articles of Association' includes all the rules of running a Limited Company, the principals of which will be agreed by the Directors and the shareholders. Typically companies use the Companies House's model Articles of Association, which includes default rules around liability of members, Director's roles and responsibilities, appointment of new Directors, distribution of shares, and other details. You are allowed to make changes to the model Articles of Association as long as you don't include anything illegal.
Among the various options of legal structures for new contractors, the popularity of Limited Companies is growing because of their many advantages. However some aspects of a Limited Company may appear challenging to new contractors.
As you can see, there are more advantages to setting up a Limited Company as opposed to disadvantages. Whether you want to register as a Limited Company will depend on several financial, legal and even psychological factors. A Limited Company is ideal for you if:
Let's say you have decided to set up a Limited Company. Before starting a business, you need to register your company with Companies House. You need to provide the following details for registration.
Once you have the above details, you can register a company by paying a registration fee to Companies House.
There are three ways of registering a Limited Company with Companies House, and the cost varies by your choice of method.
As you can see, it is not difficult for individuals to start their own Limited Companies. But, compared to a sole trading organisation, the process of setting up a Limited Company is more complicated. New contractors have to worry about many other things like managing finances, generating ideas to secure clients, building their business network, etc. Our site has many tools for Limited Company contractors to help them with invoicing and accounts, including managing balance sheets. If you are considering hiring an external agency, you can get in touch with Tempo, who will assist you in accounting, taxation and company secretarial services.
Tempo also provides company registration services, including finding an exclusive name. If you are operating your business from a home, and you don't want your home address to become publicly available, you can consider the registered office service of Accounts Direct.
You may also find the following contractor calculators useful for your salary and tax calculations.