If you’re thinking about starting up, or have been working via your own limited company for some time, there are a number of potential tax traps lying in wait for unsuspecting directors!
In this article, Emily Coltman FCA, chief accountant to award-winning online accounting software provider FreeAgent, gives her five top pitfalls to avoid.
1. Don’t forget: you and your company are not the same entity!
It’s vital to remember that when you set your business up as a limited company, you do not become the company. The company is a new, separate legal entity in its own right.
Think of it a bit like buying a new car: you own the car, you drive the car where you want it to go, you fill it with petrol, insure it and get it serviced, but you don’t become the car!
This fact is particularly important because it has a key knock-on tax effect, which we’ll explore now.
2. Take too much out and you’ll pay more tax
A company can pay you in three different ways:
- It can pay you a salary for the work you’ve done.
- It can pay you dividends on the shares you own in it (so long as it has made a profit)
- It can pay you back for costs you incur personally on the company’s behalf, for example, if you travel on company business in your own car.
However, if you take more money out of the company than it owes you, you could find yourself with an extra, unforeseen tax bill.
If you’re not sure how much you can take out of your company safely, talk it through with your accountant.
3. Working from home? Be careful how much you claim
If you previously worked as a sole trader, you may have enjoyed a generous claim for working at home, which could have included a percentage of costs such as rent, council tax and mortgage interest.
The rules for claiming working from home costs are stricter for company directors, who are only allowed to claim the extra costs incurred by working at home, such as electricity or gas. Fixed costs that would be incurred anyway, such as rent, are off-limits. If you claim those back from your company, you will pay extra tax.
Also, strictly speaking, company directors may only claim costs for working at home if the work they do at home constitutes “substantive duties” – in other words, the work earns money for the company. If you claim home working costs when the work you do at home is pure admin, you will pay extra tax.
Read our dedicated guide to claiming working from home expenses.
4. Claiming for food and drink? The rules are more different
If you’ve come from self-employment (where you’ve been a sole trader), you’ll be used to not being able to claim food and drink when you’re out and about on business, except in certain circumstances.
This time, the rules are more generous for company directors! You can claim back from your company the cost of food and drink whenever you’re travelling on business.
5. VAT flat rate scheme: be aware of the limited cost trader rate
You may have heard of the VAT flat rate scheme as something that can save all businesses, including limited companies, time and money.
In April 2017, a new rate of 16.5% was introduced for any businesses that use the flat rate scheme and buy only a few goods. This rate is called the “limited cost trader” rate and greatly reduces the potential cash savings for businesses selling their own services.
If you think you could be a limited cost trader, remember to use the correct percentage when working out your VAT. You may be able to save money by coming off the VAT flat rate scheme or even de-registering for VAT altogether, but do discuss this in detail with your accountant before you make any decisions.