How does a Limited Company work - 2011-12

Anyone over 16 years of age can set up a Limited Company. There are three main reasons for setting up a Limited Company
1. Image – some people think a business looks more professional and established if it has ‘Limited’ at the end of its name.
2. Limited Liability – if the business becomes insolvent and goes into liquidation – the assets (eg. Personal house, car) of the owners of the business are protected, only the assets belonging to the business will be lost.
3. Tax savings – profits of a limited company are taxed at 20% compared to 29% for a sole trader or partnership. You form a Company at Companies House. This can be done by an accountant (we charge £70.00 + VAT for this service).
You need several things to set up a Company
1. A unique name (eg XYZ limited)
2. A registered office address (your place of business/ home)
3. At least one Director (probably yourself) – this person runs the Company
4. At least one shareholder (probably yourself) – this person owns the Company
When the Company is set up, a bank account can be opened for the Company and the Company can start to trade. Invoices should have the name of the Company on then and the money generated should be put in the Limited Company bank account.
Every year, the Company has to prepare accounts showing how much profit it made (Profit & Loss account) and the solvency of the business (Balance Sheet)
The Company pays tax on its profits at 20%. This is payable 9 months after the year end date.
The director takes a salary from the business. This is an allowable expense within the business and reduces the profits of the business. In 2011-12 the most tax efficient annual salary was £7,225 as no Employees National Insurance is payable at this level.
The shareholder is allowed to take dividends from the Company. These are taken from the after tax profits of the Company and unless the shareholder is a higher rate taxpayer then there is no tax liability on the dividends.
An example of the accounts of a business is
Year ended 31 March 2012
£
Sales 62,225
Expenses -10,000
Profit 52,225
Salary -7,225
Taxable Profit 45,000
Tax @ 20% -9,000
Profit after tax 36,000
Dividends -31,000
Retained Profit 5,000
Here, the only tax payable is the £9,000.00. Assuming that the Director and Shareholder are the same person and he/she has no other income. There is no tax or NI payable on the Salary as the director earned less than the National Insurance threshold and no tax payable on the dividends as total income is less than the Higher Rate tax band.
If a sole trader had earned this much, then the tax calculation would be
Tax on Profit of £52,225
£7,475 @ Nil
£35,000 @ 20% = £7,000
£9750 @ 40% = £3,900
NI on profit of £52,225
£7,225 @ nil
£35,250 @ 9% = 3,172.50
£9,750 @ 2% = £195.00
Class 2 NI £130.00
Total tax and National Insurance bill £14,397.50
The tax saving is therefore £5,397.50 (£14,397.50 – £9,000.00).
Disclaimer
Seek professional advice before putting this into practice. We will not be held responsible for this advice as there are many variables that may change how this works in practice. You can contact us on 0161 621 9973 for advice.