Question: I have a successful consultancy business which I run as a self employed person. I have been told that I could save tax if I form a limited company. Is this correct?
Answer: It is possible to legitimately reduce your tax bill by forming a limited company but there are a number of issues to consider. On the plus side, operating via a limited company allows the business owner to reduce their national insurance (NI) liability by paying a low salary topped up with regular dividends which are not subject to national insurance. This means that the 9% NI paid by self employed persons on profits between £7,225 and £42,475 can be avoided. In addition, self employed individuals are taxed on profits generated rather than amounts taken from the business meaning they may be subject to 40% or higher tax on profits that they have not actually received. This is not the case for companies as the employees/shareholders are only subject to tax on the salaries/dividends paid. In addition to the tax savings, there are other benefits such as the protection of personal assets in the event that trade takes a turn for the worse.
However, there are a number of possible downsides that must be considered. The record keeping and accounts filing requirements for a company are more onerous than for a sole trade and will therefore likely incur higher professional costs. An abbreviated version of your annual accounts will need to be filed at Companies House meaning that your information will be publically available. In lean times it may not be possible to pay dividends as they are a distribution of profits so you may need to swap to paying by salary which has higher NI than that of a sole trade. You will also need to consider how you provide any company cars or vans as the tax treatment for companies is very different to that of sole traders. Finally, if you work regularly with the same client, HMRC may question whether you are really an employee for tax purposes which can have adverse tax consequences for you if you trade via a company.
There is no simple answer. If you profits are a minimum of £20,000 per year, speak to your accountant to explore the issue fully.