PostHeaderIcon Why a limited company is the most popular form of business association in UK?

When you start your business one of the first decisions you will need to make is which legal structure to go for.

A limited company is the most popular form of business association in UK. One of the most important factors which distinguishes a company from other forms of organization is that a company is a distinct legal entity separate from its members. This means that the assets and liabilities of the business belong to the company itself.

A key consequence of the fact is that a company’s members have limited liability. The company itself is liable without limit for its own debts. If the company buys goods from another company it owes the other company money.

Limited liability is a benefit to members. They own the business, so might be the people whom the creditors logically asked to pay the debts of the company if the company is unable to pay them itself. Limited liability prevents this by stipulating the creditors of a limited company cannot demand payment of the company’s debts from members of the company.

It’s important to know that although the creditors of the company cannot ask the members of the company to pay the debts of the company, there are some amounts that members are required to pay, in the event of a winding up.

  1.  Company limited by shares – any outstanding amount from when they originally purchased their shares from the company. If the member’s shares are fully paid, they do not have to contribute anything in the event of a winding up.
  2. Company limited by guarantee – the amount they guaranteed to pay in the event of a winding up.

As opposed to a company - as a self-employed person the liability sits with you personally. If your business runs out of your money it is your problem, and you could lose your wealth. Also partners are jointly and severally liable for all debts and liabilities arising under any contracts made which bind the partnership to the full extent of each partner’s wealth.

One further difference between a limited company and a self-employed person/a partnership is the way in which each is taxed.

  1. A company pays tax on its profits and directors are taxed on what they receive in remuneration from the company. With a limited company the only way to get money out is to be an employee and take a salary (e.g. being a director), or take the profits out (a dividend).
  2. If you are self-employed you are taxed on the profit you make. You declare this in your annual return, and must also pay National Insurance Contributions. On a monthly basis you can take drawings from your business to live on. When there is a partnership - each of the partners are taxed on their share of the profit, irrespective of how much or how little they have taken out of the business (drawings).

There are simplified examples how to calculate taxes:

  1. Limited company

- Profit before salaries’ deductions:     £300,000

- Salaries to directors:                       £100,000

- Company pay tax on:                      £200,000

- Directors pay tax on:                      £100,000

The tax is split between the company and the directors:

The company will pay corporation tax at 21%:

£200,000 x 21% = £42,000

 

The directors will be taxed at income tax rates (up to 40%):

£100,000 x 40% = £40,000

Total tax on company’s earnings: £82,000

 

  1. Partnership/Self-employed

- Profit: £300,000

- Drawings to partners/self-employed:     £100,000

- Partners/self –employed pay tax on:     £300,000

The partners/self-employed will be taxed fully at income rates (up to 40%):

£300,000 x 40% = £120,000

 

As a result, in the above example, the company and the directors are (£120,000 - £82,000) £38,000 better off.

 

Find out more:

Corporation Tax rates: http://www.hmrc.gov.uk/rates/corp.htm

Rates and allowances – Income Tax: http://www.hmrc.gov.uk/rates/it.htm

 

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