The use of Limited Companies by small business


Back in the day few SMEs used limited companies in their pursuit of a living, now it seems everybody has one – what changed?

There are currently over 500,000 companies in England and Wales with just one employee. In the 1980s such incorporations only took place to shield the business owner from the financial risk of failure – so why the shift in preference?

Why do SMEs use companies?

Most people’s guess will be tax – and there was a time when there was a significant tax saving to using a company, but that has reduced greatly - disappeared or reversed in some cases. Don’t feel too bad if that was your guess – there is still a healthy National Insurance (NI) saving available.  

Small company profits are usually split between salary and dividends in such a way that NI is not payable, yet the employee is treated as a low earner and thereby credited with a full NI contribution for the year. There is no level of dividend that can affect this – you can take a £1m dividend and still be a low earner for NI purposes. Silly isn’t it?

A sole trader with income over £50,000 will pay NI of £3,300 p.a. plus 2% on profits above £45,000.  Even with additional accountancy costs for a company of say £1,500, with nil NI this is a win for you and a win for us (with no loss of benefit entitlements).

Recent changes to the way dividends are taxed have eroded this advantage significantly so we are often asked if there are any other tax advantages to be had.

Just NI savings?

For those earning above £60,000 per annum the answer is better – you get to choose what your highest rate of tax is.

Owners are only taxed on what they draw from the company. This can be kept down to the company and lower personal rate of 20%. You do need the discipline of leaving the money in the company – often a point of human failing.

Thus many use a company as a safety valve against higher rates of tax.

Non-tax advantages include

  • ·         Limited/no liability on the owners for business debt
  • ·         Trading name protection
  • ·         Retirement and succession planning made easier
  • ·         Image and public availability of information to credit assessors
  • ·         Often companies prefer to engage other companies, not individuals, out of fear of the rules against disguised employment

        And some downsides

  • ·         Additional accounting and compliance costs
  • ·         Information about your business is publicly accessible
  • ·         7.5% additional tax on dividends
  • ·         Strict deadlines for filing
  • ·         If the company is found to be a disguised employment all the expenses could be disallowed – a sanction unlikely to apply to a sole trader

      Deciding whether to operate as a limited company is no easy decision. Scodie Deyong LLP is here to help, not only with getting you off on the right foot but by ensuring you stay on track as your circumstances change.


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