What’s the difference between a company limited by shares or guarantee?

If you’re running a business, there are a few different directions you can go in terms of legal structure. And the structure you decide to go with will have huge implications on how you run the business, seek funding, prepare records, and pay taxes. 

One common option is to set up your business as a limited company. And, when you do, you have the choice to be either limited by shares, or limited by shares. 

Here, we’ll be looking at the differences between these two by answering these questions:

• What is a limited company?
• What is limited by shares?
• What is limited by guarantee?
• How do limited companies get funding?
• How much tax do companies limited by shares need to pay?
• How much tax do companies limited by guarantee need to pay?

Businesses can choose to become limited companies (LCs) through a process called incorporation. To do this, you need to register your company at Companies House. Any size of business can become a limited company.

After incorporation, the company is a legally separate entity from the directors and shareholders. This legal structure protects the owners’ finances, so they’re not required to pay any company debts or losses from their personal funds. 

If the company goes bust, they are refunded the ‘nominal value’ of their shares. The nominal value is just an arbitrary amount, usually quite low, assigned by directors.  

When you incorporate, you can seek out investors who can buy shares in your business in exchange for a share in the profits. In this regard, you have the choice to become a:

• Private limited company (Ltd) – Shares can only be sold to private investors.
• Public limited company (PLC) – Shares are open to the general public on the stock market. 

After choosing to become a public or private limited company, you’ll also have to decide whether it will be limited by shares, or limited by guarantee.

This kind of limited company sells shares to investors (privately or publicly) who will share in the company’s profits through dividends. 

The dividend amount depends on how much stock the shareholder owns, and the dividend rate set by the company directors. For example, if the dividend is 90p per year, and you own 100 shares, you’d get £90 in dividend payments at the end of the fiscal year. 

The price of the company’s shares on the stock market don’t necessarily affect dividend payments, it’s just an amount decided by the company owners, and agreed upon by shareholders. However, usually the dividend amount will increase with profits.

The main difference with a limited by guarantee company is that any profits they make are invested back into the company, rather than paid to investors. This kind of limited company is normally used for social enterprises like non-profits and charities. 

Instead of shareholders, these limited companies are funded by guarantors. A guarantor can be any person or corporate body.

They invest a fixed amount of money into the company and register with Companies House. The amount they invest has to be repaid in full if the company goes bust. 

Because there are no shareholders, a company limited by guarantee cannot become a public limited company (PLC). 

Companies limited by shares will need to pay corporation tax. This is a flat rate of 19% on all taxable profits the company makes.  

Taxable profits refers to the company’s income after all business expenses have been deducted

For example, if your company’s annual income is £100,000, but you spend £20,000 on essential running costs, you’ll only have to pay corporation on the remaining £80,000. 

In this case, you’d have to pay £15,200 in corporation tax (19% of £80,000)

Dividend payments are made after paying corporation tax, so they don’t count as a deductible business expense. 

The term ‘taxable profits’ refers to any profits you make from

• doing business – these are called trading profits
• investments
• selling assets for more than they cost – these are called chargeable gains

Limited companies based in the UK pay corporation tax on any profits they make in the UK and abroad.

Alternatively, if your company is based outside the UK, but there is an office or branch within the UK, then you only pay corporation tax on profits made from UK activities. 

Because companies limited by guarantee re-invest their profits back into the business, they don’t need to pay any corporation tax. 

Even though they don’t have to pay corporation tax, they do still need to prepare records and send them to Companies house, just like any other limited company. 

The Countingup business current account makes it easy to manage all your financial data in one simple app. The app comes with free built-in accounting software that automates the time-consuming aspects of bookkeeping and taxes. 

You’ll receive real-time insights into your cash flow, profit and loss reports, tax estimates, and the ability to create invoices in seconds. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward.

Find out more here.