Limited company advantages and disadvantages

Limited company advantages and disadvantages

A limited company is one of the most popular business models for all sizes of organisation. This is due to the many benefits it provides over other types of legal business structures. Whether you choose to register a commercial (‘for-profit’) company limited by shares or a non-profit company limited by guarantee, there are a number of perks that far surpass those available to the sole trader or contractor working through an umbrella company. Below we provide an overview of the many limited company advantages, along with an outline of the potential downsides of company formation when compared to the sole trader structure.

Top 10 limited company advantages

The principal reasons for trading as a limited company are limited liability, tax efficiency and professional status. However, there are a number of other limited company advantages to be had, each of which we discuss below:

  • Minimising personal liability
  • Professional status
  • Tax efficiency and planning
  • Higher personal remuneration
  • Separate legal identity
  • Credibility and trust
  • Investment and lending opportunities
  • Protecting a company name
  • Pension
  • Splitting income

1. Minimising personal liability

The biggest benefit of forming your own company is limited liability protection. Quite simply, this means that if your company runs into trouble, your personal assets are secure. A limited company is treated as a separate legal entity; a legal ‘person’ in its own right. Therefore, the business is entirely separate from the people who own and manage it. Any debt, losses or legal claims associated with the company are the responsibility of the company – not the owners (shareholders/guarantors) or directors.

As a shareholder, you will have no legal obligation to pay more than the value of the shares you have taken in the business. If a company runs into financial difficulty, the personal assets of shareholders are protected beyond the nominal value of their shares. Therefore, if your company is unable to pay its creditors, you will only be required to contribute the nominal value of your unpaid shares. This could be as little as £1, depending on the number of shares you issue and purchase.

Sole traders, on the other hand, run a much higher risk. They are personally liable for any and all business debts, losses and liabilities. As a sole trader, there is no separation between you and your business. If the business owes money, you owe money. Therefore, your personal assets, including your home and savings, could be seized to pay your creditors.

Limited liability is crucial if you plan to provide high-value supply or services that could lead to liability claims. If any such situation were to arise whilst running your business as a limited company, you would not be forced to use your own assets to cover these liabilities, unless you gave a personal guarantee to the company or you were found guilty of wrongful trading.

2. Professional status

Your professional status and image will increase when you start trading as a limited company. Whilst the activities, ownership structure and internal management of your business may be the same, regardless of which legal structure you choose, companies are held in higher regard and create a better impression.

The difference in perception is simply due to the fact that incorporated companies are more rigorously monitored. They have more complex accounting and reporting requirements, their statutory compliance obligations are much greater, and their corporate details and accounts are published on public record where they can be inspected by other individuals and businesses.

A more professional image, coupled with the benefits of corporate transparency, could also help you in a multitude of other ways, such as:

  • Attracting new investors.
  • Accessing a wider range of lending opportunities.
  • Expanding into different locations or markets.
  • Creating a valuable and trusted brand identity.
  • Competing on an even playing field with other businesses in your industry sector.

3. Tax efficiency and planning

Limited companies pay 19% Corporation tax on profits, as opposed to 20-45% Income Tax paid on sole trader profits. This offers greater flexibility for tax planning.

Reinvesting surplus cash
Rather than withdrawing all available profits each year and paying more personal tax on top of your Corporation Tax liability, you can retain surplus income in the business to pay for future operational costs and growth. This makes more sense than withdrawing all profits, paying Income Tax and reinvesting your own finances when the business needs additional capital.

Deferring personal income
You can defer the withdrawal of profits to a later tax year in which a lower rate of business or personal tax tax is due. This is an efficient strategy if the withdrawal of all available profits would take you into a higher Income Tax or Dividend Tax bracket.

4. Higher personal remuneration

By setting up a company, you could reduce your Income Tax and National Insurance Contributions (NIC) by taking a combination of a salary and dividends. If you keep your director’s salary below the NIC lower profits limit, you will not have to pay any Income Tax or Class 4 National Insurance on these earnings.

The rest of your income can be taken as dividends, which are paid from post-Corporation Tax profits. You will not have to pay any personal tax on the first £5,000 of dividend income in a single tax year. Above this sum, you will be required to pay dividend tax, but this is invariably lower than Income Tax rates.

Depending on your annual profits, you could save hundreds to thousands of pounds in tax every year, simply by operating as a limited company rather than a sole trader.

5 . Separate legal identity

Unlike the sole trader structure, a limited company is a legal ‘person’ in its own right, with an entirely separate identity from its owners and directors. As a result, companies can enter into contracts in their own name and are responsible for their own debts and liabilities.

The owners are only liable for the value of their unpaid shares or personal guarantees, rather than the full extent of the company’s liabilities. If a company becomes insolvent, it is the business itself which is declared bankrupt, not the shareholders or directors.

Furthermore, this means that companies enjoy perpetual succession and survive the death or ownership of the original shareholders or guarantors. The business can be sold or transferred to other people at any time, thus enabling the company to continue to exist with minimal disruption to clients and employees.

6. Credibility and trust

The professional, corporate image provided by the limited company structure will add valuable prestige and credibility to your business. In fact, certain businesses and agencies, especially in the IT, finance and construction industries, are only prepared to engage with other incorporated companies. This is usually due to the level of risk involved in the contracts they award.

If you’re likely to be dealing with sensitive information, complex IT projects or large-scale construction contracts, for example, your clients will demand limited liability protection from any contractors they hire, because the associated risk of such work is particularly high. In most cases, sole traders are simply not considered for any such type of work, so a company really can improve your competitive advantage.

7. Investment and lending opportunities

Companies can have multiple owners, so it is possible to raise additional capital by selling portions (‘shares’) in the business to new investors. Generally, companies also have more lending opportunities than sole traders, and certain banks will only lend to incorporated businesses. Furthermore, it is often possible to secure a loan for a company without the need for shareholders or directors to provide security against their own property.

8. Protecting a company name

All company names must be entirely unique, so no two companies can be set up with the same name or names which are very similar to one another. The official name of your company cannot be used or registered by any other business. Sole traders do not enjoy this protection.

9. Pensions

Companies provide the opportunity to invest pre-tax trading income in a company pension scheme, as opposed to investing withdrawn income in a personal pension after the deduction of business tax and personal tax.

10. Splitting income

If you own a limited by shares company, you can issue shares to your spouse or family members. This will allow you to split your business profits and minimise personal tax liabilities. By issuing dividends to a spouse or children, for example, you can take advantage of their tax-free Personal Allowance, basic tax rate and the £5,000 tax-free annual dividend allowance. This is incredibly beneficial if you are the sole or main wage earner and/or you regularly provide financial support to your children.

Disadvantages of a limited company

There are some less favourable aspects associated with limited company formation, as one would expect from anything that provides so many benefits. However, most of these perceived disadvantages pale in comparison to the huge potential for savings and professional improvement, not to mention the financial protection you will enjoy.

  • Must be officially incorporated at Companies House.
  • Required to pay a registration fee to Companies House to incorporate.
  • Company name is subject to certain restrictions.
  • Not suitable for undischarged bankrupts or disqualified directors.
  • Required to disclose personal and corporate information on public record.
  • More complex and time-consuming accounting requirements.
  • May need to appoint an accountant to help you with your tax affairs.
  • Strict procedures for withdrawing money from the business.
  • confirmation statement and annual accounts must be filed at Companies House each year.
  • Must send a Company Tax Return and annual accounts to HMRC every year.
  • Must adhere to strict record-keeping requirements, including taking minutes of meetings and recording all decisions taken by directors and shareholders.
  • Number of company registers and records must be maintained and made available for public inspection at your registered office.
  • If you make any changes to your company details, you must notify Companies House immediately.

About sole trader businesses

Setting up as a sole trader is one of the easiest things to do in terms of registration and administration requirements. However, there is no legal distinction between the business and the sole trader, as there is with the limited company structure.

This means you would be wholly and personally responsible for all business debts and liabilities. Your home and other assets will be at risk if you are unable to meet your financial obligations.

On the flip side, because there is no legal distinction between your personal finances and business finances, there is no need to go through any complex procedures to remove money for personal use.

Pros and cons of the sole trader structure

The sole trader structure is ideal for many small business owners, particularly freelancers who have only a few clients and/or an annual income below £20,000. However, there may come a time when it is financially or professionally beneficial to consider limited company formation. If you reach that point, your first port of call should be an accountant who can advise on the best course of action.

ProsCons
Quick and easy to set up online and no need to register with Companies House Unlimited personal liability for debts and legal claims
No need to pay a registration fee to HMRC More challenging to raise capital and acquire loans
Typically low startup costs and expenses Can only be set up and owned by one person
Easy to remove profits for personal use Required to pay Income Tax between 20-45%
Minimal accounting costs and requirements You will be responsible for paying your own tax and NIC
You will own all business profits and assets Many firms refuse to do business with sole traders
No requirement to disclose accounts or personal details on public record Not eligible for Statutory Maternity Pay
No requirement to make business records available for public inspection The professional status of sole traders is not as highly regarded as the limited company structure
Minimal paperwork and record-keeping requirements No option to defer withdrawals until a later tax year or reinvest surplus cash without paying tax
No need to maintain a registered office address or service address Pension options are less tax efficient
Fewer restrictions when choosing a business name Unable to issue profits to a spouse or family member as tax-free dividend payments

Limited company or sole trader?

There is no doubt that company formation will reduce your liability in the event your business faces financial difficulty. A limited company also offers many tax benefits, there are numerous advantages to having a prestigious professional image and status, and you can set up a company for non-profit or charitable purposes.

The benefits must, however, be weighed against the additional time and money required for the administration and accounting of a limited company that would not otherwise be required if you operated as a sole trader.

It’s free to set up as a sole trader and there is very little administration associated with running this type of business, which makes it the perfect structure for many freelancers and small business owners who are just starting out or have very few clients.

For many people reading this blog, the decision will be easy. However, every business is unique. To ensure the best structure is chosen, your decision should be based upon your own personal preference, in addition to professional, tailored advice from an accountant or advisor who has a clear understanding of your business objectives and long-term plans.

Self Assessment for company directors & sole traders

A young businesswoman raises her pen in front of a window as a male colleague smiles.

You can register with HMRC in a matter of minutes by providing a few key details online.

Sole traders (and company directors who receive remuneration other than a salary through PAYE) must register for Self Assessment by 5th October after the end of the tax year being reported in the tax return. For the current 2017-18 tax year, you must remember to register yourself by 5th October 2018. You can do this in a matter of minutes by providing the following details online for HMRC:

  • National Insurance Number.
  • Your full name, address, and contact details.
  • Details about the business (name, address, start-date of trading activities, nature of activities).

After registering for Self Assessment, HMRC will send a letter to your contact address. This will contain your personal Unique Taxpayer Reference (UTR) and information about your tax obligations and filing responsibilities.

Filing and payment deadlines for Self Assessment (2017-18 tax year)

The tax year for Self Assessment runs from 6th April – 5th April. Therefore, the current tax year began on 6th April 2017 and will end on 5th April 2018. You can file your tax returns by post or online, and you can pay your Income Tax and National Insurance Contributions electronically.

  • Paper tax returns must be received by midnight 31st October 2018.
  • Online returns must be filed by midnight 31st January 2019.
  • Income Tax and National Insurance must be paid in full by 31st January 2019.

You must send a tax return even if you do not have any tax to pay. If you miss the final filing deadline by more than 3 months, you will receive a £100 penalty. However, this fine may be waived if your make an appeal to HMRC. If you are late paying some or all of your tax, you may be charged a percentage of the outstanding balance.

19 Comments

  1. Hi,
    I am impressed with the answers you have supplied to others, and hope you can help us.
    We, husband and wife,, are considering the possibility of setting up a non-profit making limited company for the purpose of owning our road, which is not adoptable by the local council.
    We and neighbours have spent a lot of money improving the road, which now seems at risk of damage from a new development nearby, so we need insurance and legal status. If we have, say, 3 directors with £1.00 shares each, would this basis be practical in law?
    We would then need to apply for the deeds from, I think, Chancery Division.
    My husband is currently Chair of our Residents Association but this is likely to disband soon.

    • Dear Sheila

      Thank you for your kind words. Unfortunately we cannot advise on the structure of any business as we are not professional advisors and we would advise that you speak to an accountant or lawyer to get the correct advice to deal with this more unusual business concept.

      Best Regards,

  2. What hapoens with the state pension siruatuon when you become a ltd company.

    • Dear Am Baio,
      We are not pension advisors however if you are receiving state pension and form a limited company then you would declare the state pension on a tax return along with any income taken from the limited company.
      Kind Regards,
      Rapid Formations Team

  3. I am changing from sole trader to limited company is it possible to retain my gross payment status for tax purposes?

    • Dear Stan,
      Thanks for your message.
      We are not experts on Construction Industry Scheme tax so I would advise you either call HMRC on 0300 200 3210 or speak to an accountant.
      Kind Regards

  4. Ohh thanks very much for advising i think limited companies has more advantages than sole bcs personal property are secured.name of company is boomed etc

  5. Must be officially incorporated at Companies House
    Required to disclose personal and corporate information on public record.

    can you explain more on those two disadvantages of a limited company

    • Dear Lee,
      Thank you for your message. The two disadvantages you have highlighted are very similar in nature. The point being made is purely from a privacy perspective in that if you were to set up a business as a sole trader or partnership (not Limited Liability Partnership), your information would remain private, whereas limited companies have to comply with the Companies Act which requires certain details to be available to the public through the Companies House website (such as the names of directors, the company address etc).
      Best regards,
      Rapid Formations Team

  6. If I am a sole trader registered for vat and change to a limited company do I still have to be vat registered as a limited company ? thanks for your time,
    Kind regards,
    Carl

  7. Many thanks for your valuable advise you give people.

    I am forming a ltd company where am a sole director n shareholder. Please advise in the following;

    Does nominal capital of kes 100k mean I have to contribute from my pocket?

    Does fees or charges by advocate form part of the nominal capital?

    In case I need more capital to run day to day activities and pay salaries, can I borrow from a friend?

    Can I dictate the salary I want and when can I start paying myself?

    • Hi Peter,

      You’re most welcome – I’m pleased to hear that you find the advise useful.

      1. If you set the nominal capital of your shares at £100,000, you will be personally liable to contribute £100,000 to the company if it is unable to pay its debts. You would not have to contribute that sum of money initially, unless you were using it as start-up capital, though I would strongly advise against setting such a high nominal capital. Perhaps consider issuing 10 or 100 shares with a nominal capital of £1/share – this is a popular choice, but it is entirely up to you and something you may wish to speak to an accountant or professional advisor about before making a decision.
      2. Fees and charges paid to solicitors/accountants/advisors are deductible expenses that must be included in your accounts if the payments are made from your company’s bank account. These expenses have nothing to do with nominal share capital.
      3. It is solely your decision if you wish to borrow money from friends or family, but you must record this income and report it in your accounts.
      4. You can choose how much to pay yourself as a salary and you can do this as soon as the company has available funds. Your director’s salary will be a tax-deductible expense for the company.

      I would strongly urge you to seek professional advise from an accountant regarding these matters, especially if you are considering investing a significant sum of money in the business. I’m not an accountant, so I’m afraid I cannot provide any specialist advise.

      Best wishes and good luck with your new business!

      Rachel Craig

  8. Hi Rachel,

    I run a sole trader business and we are going to exceed VAT Registration Threshold so I am going to change to Ltd Co. before we register for VAT.

    With this in mind, can you advise whether I will be required to register for VAT as a Ltd Co. immediately or is the turnover as a sole trader disregarded due to the change of legal entity (and then wait until the turnover as Ltd Co. nears VAT Threshold)?

    I have also invested around £15,000-£20,000 over the past few years on plant which would be VAT deductible so would not want to lose out on the opportunity to claim this back… in which case should I register for VAT as a sole trader and delay Ltd Co. status for a year or two?

    • Hi Ron,

      Thanks for your message.

      This is quite a complex situation so I’m afraid I am unable to give you a concise answer. I would advise contacting HMRC directly to explain what you wish to do and find out what your options are.

      Sorry I cannot be of more help.

      Best wishes,

      Rachel Craig

  9. When changing from a sole-trader to a limited company who do I need to inform.

    • Hi Richard,

      Thanks for your email.

      You need to inform Companies House, HMRC, your clients, suppliers and all business-related service providers.

      To register your existing business as a limited company, you must complete an application for Companies House. It’s very easy and only takes a few hours. Find out more here: https://www.rapidformations.co.uk/help-centre/steps-to-forming-a-company/

      You will also need to tell HMRC that you are stopping self-employment. Click this link for guidance on how to do that: https://www.gov.uk/stop-being-self-employed

      When your company is registered and you are ready to start trading through it, you should update your website and business stationery with the required details. You can find out about these legal requirements here: https://www.gov.uk/running-a-limited-company/signs-stationery-and-promotional-material

      You may wish to open a business bank account in your company name, so you will have to inform service providers and suppliers about your new bank details. This will also affect the information you include on your client invoices.

      I hope this information helps but please get back to me if you want to know anything else or need help setting up your new company.

      Best of luck,

      Rachel

  10. can you help me set up as a sole trader?

    • Hi Ranjit,

      We do not deal with sole trader businesses because they do not have to be registered at Companies House. However, it’s really easy to set up as a sole trader. You can do it online via HMRC. This link will explain how to do that: https://www.gov.uk/set-up-sole-trader/overview

      Please let me know if you need anymore help.

      Best wishes,

      Rachel

Leave a Comment

Your email address will not be published. Required fields are marked *

Limited Company Formation

With a free business
bank account

From £9.99 plus VAT