Limited company basics for contractors

Most contractors work via 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 contractor 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 2.1m actively trading companies currently (2021 data), compared to 3.1m sole traders and 353,000 ordinary partnerships.
• The liability of a company’s members is limited should things go wrong.
• A 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. This 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. This is despite the April 2016 dividend tax hike, which reduced the tax benefit over alternative business structures.
• Unlike traditional salaried employees, company shareholders draw down most of their income in the form of dividends. Dividends are not subject to National Insurance Contributions.
• 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 company guide.

How do you register a limited company?

There are several ways to register a company;

1. Directly, via the Companies House Web Incorporation Service – takes up to 24 hours (£12).
2. Directly, by post, using Form IN01 – this takes 8 to 10 days (£40).
3. Same-day incorporation via Companies House (£100).
4. Via an intermediary, such as a formations agent (various prices). You can set up a company from £10.95 via Clever Formations. They do all of the legwork on your behalf.
5. Via an accountant (various prices, sometimes included if you sign up as a client).

The cost of setting up a company is 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.

You cannot use some ‘sensitive’ words and expressions. For example, if the name implies that you are a member of a professional body when you’re not.

Overall, a fairly general, non-specific name will work well. Your company name will appear on future contracts, and your tax and accounting documents, so bear this in mind.

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. An accountant can also register your company for Corporation Tax, VAT, and ensure that your share structure is appropriate for your needs.

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. You can operate your limited company with just a single director.

Beware of the IR35 rules

If you are considering contracting for the first time, you should also be aware of the IR35 and the ‘Off Payroll’ rules.

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, the off payroll legislation is potentially more troublesome for contractors, agents, and clients alike.

We urge you to read up on how IR35 may affect you, and what steps you can take to protect yourself.

The new rules took effect from April 2021. You can find out more in our IR35 section.

Final Thoughts

Most contractors operate via limited companies. It provides a tax advantage over the umbrella route, although you will have to undertake a modest amount of admin 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.