Ask the vast majority of accountants and chances are they will tell you that if you were planning to work as a freelancer or as a sole trader of any kind, then setting up a private limited company is the most tax efficient way of doing so.
Nevertheless, there’s a pretty big leap between working as a sole trader and running a limited company when it comes to administrative demands and the kind of additional processes that need to be dealt with.
Unsurprisingly, what tends to steer many sole traders off the idea of forming their own limited company is the complexity of the jargon when it comes to taxation. Nevertheless, once you get even a basic understanding of what the terms mean and how they apply to your business, it is perfectly possible to run and operate a limited company with far greater tax efficiency than would be available as a sole trader.
Here’s a quick look at some of the key terms to help communicate what’s really involved when it comes to small business taxation:
Limited Company Tax
Perhaps the simplest and most straightforward way of thinking about a limited company in a taxation sense is that you the owner and the company itself are in fact two different entities. Limited company tax is different than the tax applied to your own income and salary. As a sole trader, the company and the business owner are one and the same.
Corporation tax refers to the tax payable on profits by all private limited companies. As it stands, in an instance where a business pulls in an annual profit of less than £300,000, corporation tax is charged a 20%. It is however important to note that as you are technically an employee/expense of the company, your own salary is not included in this total profit figure.
Employer’s National Insurance Contributions
If you have any employees, including yourself, who earn £149 or more every week, the company is required to pay National Insurance contributions for each of them. As it stands, the rate payable by the company is 13.8%.
Value Added Tax (VAT)
Registration for VAT is voluntary for businesses with revenues under £79,000 per year but mandatory for those with revenues above this level. As it stands, goods and services where VAT applies are taxed at a rate of 20%.
PAYE and Income Tax
Things get slightly more complicated when it comes to the way in which your two types of income are taxed – one as an employee and one in the form of dividends which you are entitled to as the company’s owner or director. What’s worth remembering here is that dividends are taxed at a lower rate than standard PAYE (pay as you earn) income tax, so it is important to seek advice if necessary in order to efficiently balance your total income. You can source this expertise from companies such as Francis Clark Tax Consultancy, offering specialist tax support.
Employee’s National Insurance Contribution
As for the National Insurance contributions which must be paid by employees, including yourself, National Insurance currently stands at 12% for those earning above £149 a week and less than £797 a week. If you’re in the bracket earning more than £797 each week, the first £797 will be taxed at the full 12% rate while earnings above this threshold will be charged at 2%.