Most contractors work via their own limited companies. Aside from the tax benefits this structure offers its shareholders, the liability of directors is also limited.
There are a number of legal and statutory obligations associated with being a company directory, however much of this burden can be easily absorbed by a specialist accountant.
In this guide, we look at what a limited company is, how the incorporation process works, and what typical tasks a limited company contractor has to undertake.
What is a limited company?
The limited company is the most popular type of incorporated business structure in the UK. There are around 2m actively trading companies currently (2020 data), compared to 3.5m sole traders and 414,000 ordinary partnerships.
As the name suggests, the liability of a company’s members is limited should things go wrong, and the company itself is a completely distinct legal entity from its directors and shareholders.
Limited companies are governed by Company Law – primarily the terms of the Companies Act 2006, and associated legislation.
What are the benefits of setting up a limited company?
- The personal liability of directors is limited, which means your personal assets are distinct from the assets owned by the business. This is a key benefit of incorporating.
- All things being equal, working via a ltd company remains the most tax-efficient way to operate a business, despite the April 2016 dividend tax hike, which has reduced the overall tax benefit over alternative business structures.
- Unlike traditional salaried employees, company shareholders draw down most of their income in the form of dividends – which are not subject to National Insurance.
- Shares can also be split between spouses, and dividend declarations can be timed to make the most out of each year’s tax-free allowances. The tax planning options are significant.
- You can create different classes of share if required. This may be useful for tax-planning reasons, or if you diversify your business at some stage and have business partners or investors involved.
- Company directors have complete control over their businesses. This is not the case if you work via an umbrella company, for example.
- Being a company director provides a professional image, and may allow you to explore a wide range of other business opportunities in the future.
The alternative to working via a limited company is to use the services of an umbrella company, as it is extremely rare for contractors to work as sole traders.
Non-contractors can work via their own companies as contractors do but also have the option to become ‘self-employed’ if they wish – or work as a ‘partnership’ with other self-employed people.
To compare the two types of business structure open to contractors, read our limited vs. umbrella guide.
How do you form a company?
There are several ways to incorporate a company;
- Directly, via the Companies House Web Incorporation Service – takes up to 24 hours (£12).
- Directly, by post, using Form IN01 – this takes 8 to 10 days (£40).
- Same-day incorporation via Companies House (£100).
- Via an intermediary, such as a formations agent (various prices). You can set up a company from £12.99 via 1st Formations. They do all of the legwork on your behalf.
- Via an accountant (various prices, sometimes included if you sign up as a client).
The costs of forming a company are very low in the UK, especially compared to other developed nations.
Each method will produce the same result, however, you may prefer to use a third party if you are new to contracting.
You will need to provide various details to Companies House to complete the formation, from details of the company’s officials, to how many shares you want to create.
During the incorporation process, you must choose a suitable company name. Some ‘sensitive’ words and expressions cannot be used (for example, if the name implies that you are a member of a professional body when you’re not), but generally, we’d suggest you use a fairly moderate name, as it will be used on all future accounting and contract documentation. You can easily change your company name in the future should you need to.
Find out more by reading 10 things you need to know before you form a limited company.
Once the company has been registered, you will receive a Certificate of Incorporation. The next stage is for an accountant to register the company for Corporation Tax, VAT, and payroll purposes with HMRC.
Forming a company may seem a little daunting for many first time contractors, but in reality, it has never been easier to do so. We recommend using the services of an accountant to take care of the whole process on your behalf, as the formation step is just one of many which need to be completed before you are fully set up in business as a limited company contractor.
What does a company director have to do?
The Companies Act 2006 outlines a number of responsibilities which company directors must take on.
The key ones are; to produce the company’s annual accounts, to submit a Confirmation Statement – a snapshot of the company at a moment in time, and keep Companies House updated with any changes you make to the company, such as a change to the company’s registered address, or the personal details of its director(s).
Directors also have to act within their powers, according to the company’s constitution. They must act within the best interests of the company, exercise reasonable care and judgement in the conduct of business.
You may also decide to appoint a company secretary, to oversee any administrative tasks, although this is not a legal requirement. A company can be run with just a sole director.
Beware of the IR35 rules
If you are considering contracting for the first time, you should also be aware of the ‘off payroll’ IR35 rules, which are set to be extended to cover all private sector contractors from April 2021 onwards (the rules already apply to public sector contractors).
If you undertake contract work via your own limited company, it is essential that your working practices and contract wording demonstrate that you’re truly ‘in business on your own account’, rather than merely a disguised employee.
The IR35 rules were first implemented in 2000, however, this latest addition to the legislation is potentially more troublesome for contractors, agents, and clients alike. The changes are complicated and ambiguous, so we urge you to read up on how they may affect you, and what steps you can take to prepare yourself.
The new rules apply from April 2021. You can find out more in our IR35 section.
Final Thoughts
The limited company route is the most commonly used structure for IT contracting. It provides a tax advantage over the umbrella route, although you will have to undertake a modest amount of administration in order to comply with your obligations as a director and to keep your accounts up-to-date.
In practice, the work involved in running a contracting company is minimal, and a specialist contractor accountant will deal with HMRC and Companies House on your behalf.
You can find out more about the taxes you will encounter as a limited company contractor here.
Take your time to browse the other guides in this section, and talk to an accountant if you have any questions about the incorporation process or the obligations you will have as a company director.
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