Starting a limited company: what to consider


This article was last updated on 20th July 2021

If you’re a sole trader, you may have heard you could save tax by running your business as a limited company. But is that true? And what else do you need to think about? We’ve rounded up some of the key things to consider before you make any decisions.

Will you pay less tax?

It depends. In some cases, you could pay less tax overall on the same amount of money earned if you trade through a limited company rather than as a sole trader. This will depend on how much profit your business makes.

When you’re a sole trader, you pay Income Tax and National Insurance on all of your business’s profits. When your business is a limited company, there’s Corporation Tax to pay on the profit, but no National Insurance.

Depending on how much profit the company makes and how much money you want to take out, you may be able to use a combination of salary (which you pay to yourself as an employee of the company) and dividends (which you pay to yourself as a shareholder) to maximise your personal tax savings. That’s because, again, there’s no National Insurance payable on the income you receive in the form of dividends.

Bear in mind that it's become less tax-efficient to take money out as dividends since April 2016, because of a change in the way dividend income is taxed. Before you pay a dividend, you need to make sure the company has enough profit to cover it – and remember that Corporation Tax must come off the company’s profit first. 

You have to prepare dividend vouchers every time the company pays a dividend. Accounting software like FreeAgent can help you check that the company has enough profit to pay a dividend. FreeAgent can also prepare dividend vouchers for you.

A note of caution

If you’re considering setting up a limited company for your business, do talk to an accountant first, because everyone’s tax situation is different and what works for one taxpayer may be bad news for another. There are a lot of potential pitfalls as well as possible savings.

Other points to consider

When you’re a sole trader, legally there is no difference between you and your business. That means that if your business is sued, so are you - and you could lose your house, your car and other personal assets.

A limited company, on the other hand, has a separate legal identity of its own. This means that if the business is sued, it’s the company that’s sued. The directors and shareholders generally won’t lose their own assets, unless, in the case of the directors, they’ve given personal guarantees or been found guilty of wrongdoing.

Some company details are public

If your business is a limited company, it must have a registered office address, which you must display on all the company’s correspondence, including emails. Limited companies must also submit accounts every year to Companies House. Anyone can then view your business’s accounts online, free of charge.

Limited company directors have certain legal responsibilities which are laid down by Companies House. Failing to meet these responsibilities can result in a director being disqualified from acting as a company director again. They could also face hefty fines or, in the worst cases, a prison sentence.

Remember, you should talk to an accountant first if you’re thinking of trading through a limited company

FreeAgent is award-winning online accounting software designed for small businesses. Try it free for 30 days.

Disclaimer: The content included in this blog post is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this blog post. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.

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