Tax advantages of setting up a limited company

When setting up your own business, you’ll have to choose a particular legal structure. For example, you can set up as a sole trader or a limited company. 

There are advantages and disadvantages to both legal structures, particularly when it comes to taxes. In this guide, we’ll outline some of the most significant advantages of setting up a limited company to help you make the right choice for your business. 

Specifically, we’ll be talking about:

• Corporation tax vs income tax
• Shareholder dividends
• Non-tax benefits owning a limited company

Limited companies pay tax on profits at 19% but sole traders need to pay income tax on all of their taxable profits. The tax rate increases depending on how much money you make, like this:

• Personal allowance: Up to £12,570 (0%)
• Basic rate: £12,571 to £50,270 (20%)
• Higher rate: £50,271 to £150,000 (40%)
• Additional rate: over £150,000 (45%)

One of the biggest advantages of setting up as a limited company is tax efficiency. Limited companies pay Corporation Tax on their profits is usually lower than income tax rates paid by sole traders. For example, small businesses with a profit of under £50,000 pay Corporation Tax at 19%, while sole traders pay income tax on their profit which ranges from 20% to 45%.

Limited companies pay corporation tax on all their taxable profits. Corporation tax is a flat rate of 19% on business profits no matter how much you earn. Limited company directors can can then minimise their tax liability by paying themselves a combination of salary and dividends. More on this below.

As a limited company director, you can pay yourself a combination of salary and dividends. You can optimise your income for tax efficiency by taking a small salary that incurs minimal personal tax, alongside dividends which are taxed at a lower rate. This means you can minimise your tax liability, whilst maximising your take-home pay.

When paying yourself a salary, you need to follow the PAYE system and deduct income tax and National Insurance Contributions (NICs). Your company can also claim business expenses to reduce its overall taxable profits.

Limited company directors can also pay themselves in dividend payments. Dividends are regular payments made to shareholders from a company’s profits. They usually act as a reward for the shareholders’ investment and an incentive to keep investing. Dividends aren’t subject to NICs and the tax rate is usually lower than income tax rates:

Tax on dividends in the UK

• Basic rate taxpayers pay 8.75% tax on dividends over the allowance
• Higher rate taxpayers pay 33.75% tax on dividends over the allowance
• Additional rate taxpayers pay 39.35% tax on dividends over the allowance

With the right combination of dividends and income from your limited company, you’ll pay less tax on earnings. You don’t pay income tax on income that falls within the Personal tax-free Allowance (£12,570) and you also get a Dividend Allowance of £2,000. For example, if you pay yourself the personal allowance limit for both income (£12,570) and dividends (£2000), you won’t have to pay any tax. After that, you can keep paying yourself in dividends, subject to the lower dividend tax. 

Forgiving tax rates aren’t the only advantage of setting up as a limited company. There are plenty of ways a limited company structure can help you out in both the long and short term. 

A limited company is a legally separate entity from its owners, meaning all of the company’s investors have limited liability. 

Practically speaking, this means that you (and your investors) are not responsible for the company’s debt, so your personal finances are safe if the business goes bankrupt. 

You can still lose money, but only the amount you’ve invested. In other words, your liability for debt is limited. Limited liability makes it much easier to grow your company and attract inventors without the risk of failure.

When you set up a limited company, you need to register the company name as a trademark. Doing this prevents other companies from trading under the same name as you. 

The main advantage is that you’re effectively protecting that name from imitators down the line. Alternatively, sole traders can have any business name they want, even if it’s the same as another business, which could lead to brand confusion and cheap imitations.  

Because of the limited liability we mentioned earlier, Limited companies are usually a much more attractive investment opportunity, making it easier to secure funding from banks and lenders. 

On the other hand, Sole traders may struggle to find investment because the investors’ personal money could be at risk if the business fails and goes bankrupt. 

In a similar vein to the last point, setting up as a limited company can give you a more professional appearance. Even if you’re a one-person operation, representing yourself as a limited company will make you sound more official. 

That extra professionalism can be a huge advantage for a number of reasons:

• You’ll be more attractive to investors. 
• You’ll appear more official in the eyes of consumers and vendors. 
• You’ll find it easier to collaborate with other companies. 
• It shows that you believe in your company enough to register it. 

It may sound simple, but the prestige of the limited company title can make all the difference in the long run.  

When you own a limited company, you’re legally required to have a separate business current account for that company. If you go down this route, we recommend that you open a current account to actively improve your financial management. 

Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

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 and start your three-month free trial today.