How setting up a limited company will cut your tax bill and limit your liability

Unlike self-employment, a business that is incorporated as a limited company is a separate legal entity to its owners (shareholders).

One of the biggest advantages of this is that individual shareholders cannot be held personally liable for any company debts. As a separate legal entity, limited companies are also treated differently for tax purposes which entails, a significant benefit for contractors.

You can choose to draw a salary from your company, depending on your personal financial circumstances. Your director's salary is still subject to Pay as You Earn (PAYE) tax and National Insurance (NI), depending on the amount. It can also be set to avoid paying any PAYE or NI.

Profits for small companies are taxed at a flat rate of 19%, compared to varying rate for employees, which can reach 40%.

The remainder of your income can be drawn as dividends from the company's net profit. Dividends do not attract NI and start attracting tax within the basic rate threshold but only at 7.5% and then 32.5% above the basic rate. This means that dividends are a much more efficient method of earning than a salary is. However, this is only possible through a limited company structure.

A company can be a very tax-efficient vehicle through which to make investments (e.g. into an executive pension), but the UK government is working to counter what they see is widespread tax avoidance by contractors. They believe that contractors are using companies to “disguise employment” and pay business levels of tax when they should be taxed as employees. Even so, contracting can be a highly lucrative way of working in the UK when compared to being a permanent employee. It also depends on which industry is worked in.

It is vital for you to seek advice from reputable and regulated accountants to ensure that you stay within the rules and do not become overwhelmed with the potentially costly compliance burden.

Take a look at the information about limited companies section under our accounting section.

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