What is a private limited company?

simon

Simon Misiewicz

4th August 2020

Article relevant to the tax year 2020/21

You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord.

What is a private limited company?

What is a private limited compamny

A private limited company is simply a limited company. You may hear them called by different names such as 

– Limited Liability Company also is known as LLP

– Private limited company also is known as PLC. This is not to be mixed up with Public Liability Company (PLC)

– Special Purpose Vehicle, also known as SPV

A limited company is a legal separate entity from you. This means any legal responsibilities is on the limited company and not on the people associated with the limited company. There are times when a limited company director waives rights to be held legally responsible for the dealings of a limited company. This is rare.

Who is involved in the running of a limited company 

 

Who runs a limited company

Directors of a limited company

There may be many company directors in a large organisation. For the vast majority of readers of this article, you likely set up with one or two directors.

Directors are often paid a salary and bonus for the financial performance of the limited company. Some directors are rewarded with shares, which they can then receive dividends from the limited company.

We discuss how directors that are also shareholders may extract tax-free money from a limited company.

Shareholders of a limited company

The shareholders of the limited company are there owners. They may or may not work within the company. Shareholders receive dividends when the private limited company makes money. They also take the risk that their capital could be lost if the business does not do very well. Shareholders are responsible for the appointment of a limited company director, whom in return is responsible for the hiring and firing of employees.

What type of business uses a private limited company?

There are no restrictions that may use a limited company. The types of business range from:

– Hairdressers

– Management consultants (albeit you do have to watch out for IR35)

– Manufacturers

– Property Developers

– Cafes

– Restaurants

– Shop retail outlets

As you can see that there is no common theme.

What is the difference between a sole trader and a private limited company?

There are two distinct differences between a sole trader that works in their sole name and a private limited company

Risk

A sole trader is an individual and they must shoulder all blame. If there is a blame there is a claim as they say. If someone prosecutes from assumed wrongdoing they can make a claim against all your personal assets. This includes your business assets, home, cars, valuables etc. There is no restriction of what may be taken if the courts deemed you are in the wrong and you now need to compensate the person affected.

The assets of the limited company are at risk but not your personal assets if someone sues for wrongdoing in a company

Tax

We will explore the element of tax that we will discuss a little later on in this article

Can one person own a private limited company?

There can be just one person that starts and runs a limited company. There is no minimum and there is no maximum. One person can happily start and run a limited company without any restriction.

Download your buy to let tax guide here, written by our property accountants

What are the tax advantages of using a private limited company?

Before we discuss the tax advantages of using a private limited company we need to first understand the sole trader tax status. A sole trader will be taxed under UK HMRC income tax bands. The rates of tax may be seen here:

HMRC UK income tax bands for sole traders

A limited company only has one rate of tax, being 19%

For the most part you would think that being a sole trader and paying income tax bands makes a lot of sense. However, let us look at an example to compare the tax paid for someone that earns £100,000

How much income tax will you pay as a sole trader on £100,000

In a limited company, you would only pay £19,000. That being a £8,500 tax saving. That said it is unrealistic that you would simply leave all the money inside the limited company. You will have an income tax liability of the money you personally take out of the limited company.

This only gives us a small part of the picture. As you know you will pay income tax to HMRC for the money you take out of the private limited company. We discuss how directors that are also shareholders may extract tax-free money from a limited company.

What are the disadvantages of using a private limited company?

There are a few things that you need to consider when using a limited company

– A limited company needs to have a set of accounts and a tax return done each year

– A limited company financial data will be shown on Companies House, which is a public domain

– You may be double-taxed on the income you earn. This is because the limited company is taxed at 19%. You personally will also be taxed on the money you take out of the limited company

You need to consider how much money you will earn in your business and how much money you need for your lifestyle. This determines the amount of tax that you will pay.

How do you form a private limited company

There are many wealth and tax considerations when you set up a limited company. However, we will deal with the basics in this article. You will need to create shares within a limited company. There are different types of shares that you can create

– Preference shares

– Ordinary shares

– Alphabet shares

Preference shares

are usually used when you wish to have ownership in the business but you want a guaranteed form of income. You will agree on an amount to invest in a limited company. You will also agree on the % return that you want each year

Ordinary shares

This is the most common format of shares within a limited company. You agree with the value of each share and how many shares each person will pay for. The greater the number of shares the greater amount of ownership that the person has in the limited company.

Alphabet shares

These are very similar to ordinary shares. The reason why I specified them is fir the flexibility for the payment of dividends. Let us imagine that both Sarah and John start a limited company with 50 X £1 ordinary shares each. An ordinary shareholder has to take out the same £X dividends per share. As such Sarah and John would need to share £20,000 dividends between them.

John is a tax high taxpayer and Sarah does not work. John gets his first £2,000 dividends tax-free. He pays 32.5% income tax on the remaining £8,000 dividends. Sarah receives the £10,000 taxfree as it falls below her £12,500 personal allowance.

It would have been beneficial for John to have an A-class share and Sarah to have a B class share. That way John could be paid £2,000 dividends, which are tax-free. Sarah would be paid £12,000, which still falls below her personal allowance and would also be tax-free.

 

You may see a number of UK landlords that use limited companies to purchase buy to let properties to save tax. That is because people are worried about Section 24 mortgage interest relief cap, where the mortgage interest is no longer allowed to be offset against the rental income.

How can our property accountants help you reduce your buy to let tax?

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