What is a Limited Company?

After becoming a freelancer or contractor, one of the first major decisions you’ll be faced with relates to your business structure. Should you operate as a sole trader? Become an umbrella worker? Or, as we’ll focus on in this article, are you better off forming and working through your own limited company?

If you’re newly self-employed, it can be challenging to know which route is right for you, but if you wish to work with agencies, you may find that they prefer you to set up your own limited company. So in this pitstop guide, we’ll cover the basics of the limited company, explaining in simple terms what it is, how it works, and any other need-to-know information.

What is a limited company?

A limited company is an incorporated business, meaning it is a separate legal entity from its owner(s), who own shares in the company.

At a glance, here are some key characteristics (and benefits) of a limited company:

• Limited liability means your personal assets aren’t at risk
• Enjoy tax planning opportunities
• Fast and simple to get up and running
• Claim a wide range of business expenses

Working under a limited company structure is a proven and highly popular way to operate as a contractor. Here are some pointers on how it works in practice:

How does a limited company work?

Being a limited company contractor is quite different from working as a sole trader. This is mainly due to the business being separate from you, the owner, which means aspects such as income, expenses and tax liabilities are the company’s, not yours personally.

All income goes through the company

As a limited company contractor, you work for your limited company, and your company holds the relationship with the client. So all invoices for work carried out are raised in the company name, and the income received is paid to your business bank account.

Expenses

Qualifying business expenses - including your salary - reduce the income to provide a profit figure on which company, or Corporation Tax, is calculated. Any profit, after this tax has been set aside, is the property of the shareholders, who can choose (subject to their IR35 status) to take some - or all - of this profit as dividends, as it is earned, or leave some of it in the company to take at a later date. As you only get taxed on dividends once you have withdrawn them from the company, you can choose to be taxed personally only on the income you need in a tax year.

So, subject to your IR35 status, you can extract earnings from your company, whether in the form of salary or dividends – both of which must be recorded for tax purposes.

Tax considerations for limited companies

Limited companies must pay Corporation Tax annually on any profit they record. If your company turns over £85,000 or more within 12 months, or you know it will do in the next 30 days you’ll also need to register for VAT, charge VAT on your invoices and file and pay this quarterly. These taxes are in addition to the Income Tax you’ll need to pay on money withdrawn from the business, which sees you exceeding the Personal Allowance threshold.

Despite the additional taxes due for a limited company, operating this way can still be of great benefit, as there can be greater flexibility about how and when you extract your money for personal use from the company, which can provide the tax efficiencies mentioned earlier.

There are several types of limited companies. We’ll define two of the most common:

What is a public limited company?

The shares of a public limited company (PLC) are available for the general public to buy freely on the stock exchange. Shareholders can purchase shares in PLCs, with their value rising or falling depending on the company's performance.

Only organisations of a certain size are floated on the stock exchange. It would be extremely unusual for a contractor to operate via a PLC.

What is a private limited company?

In contrast, a private limited company is the most popular type of incorporated business in the UK and a structure used by most contractors. Unlike a PLC, a private limited company’s shares can’t be bought and sold by the general public without permission from existing shareholders. This means that you retain complete control over who invests in it and when, if at all.

Ready to learn more about limited companies?

Of course, there is a lot more to learn about limited companies. From the advantages of limited companies to the broader considerations and details of your tax obligations, you’ll learn everything you need to know about working this way in our contractor’s guide to working through a limited company.

Whether you’re thinking of operating via a limited company, as a sole trader or through an umbrella company, Caroola has the solutions and expertise to help you thrive. To find out more about how we can help you, please get in touch.