Many entrepreneurs when starting in business opt to go down the Limited Company route without fully understanding their obligations and legislation that goes with owning a company.
UK companies adhere to the Companies Act 2006. Most people know that companies are normally required to submit accounts each year to Companies House. However, where directors and shareholders often struggle is knowing what they can and can’t do.
There are certain advantages to having your business interests in the form of a Limited Company. Such as limited liability, where the company has a separate legal identity to the owners. Also, companies pay corporation tax on profits. This is currently 19%. Self-employed workers are taxed at 20% for profits up to £46,350 (basic rate) and 40% on profits exceeding this value (higher rate). Therefore if your company is making profits in excess of £46,350 you could be saving up to 21% in tax by being limited.
Entrepreneurs are often told about the potential tax saving by word of mouth and decide to open a company. Owning a company is very different to being self-employed. Here I will discuss a few of the common pitfalls when starting a company.
1. Breach of company law
As noted above the legislation UK companies follow is the Companies Act 2006. Breach of this legislation may be considered a criminal offence. Limited liability applies to shareholders, not directors. In most cases small and micro company shareholders will also be directors.
Directors are required to keep adequate accounting records which show a true and fair view. Maintain company statutory registers and comply with filing deadlines.
2. Extraction of cash
Sole traders and partnerships can withdraw money from their businesses tax-free. However, the same rules do not apply to companies. A common example is the sole director/shareholder starts up. The business makes some sales and starts withdrawing cash from the bank account. You might be thinking what is wrong with this?
Basically, companies need to pay tax on money being withdrawn from the business. Directors can be paid a salary, unlike self-employed workers. A salary will attract tax and national insurance once the NI and personal allowance threshold has been met.
Shareholders can be paid dividends on profits, however, dividends also attract tax. The first £2,000 in any tax year is tax-free. This is called the dividend allowance. Any dividends in excess of this amount will be taxed at 7.5% up to the basic rate band, and 32.5% at the higher rate. This tax will be calculated on your self-assessment tax return each year.
3. Directors loans
As a company director and shareholder, you will likely have a loan account with your company. You perhaps often pay for business expenses personally. In the accounts, we would record the business expense. A
In point 2 I discussed that dividends can be paid to shareholders on available profits. Many startups and early-stage businesses do not see a profit in the early days, months or even years after starting a company. Therefore this can mean dividends cannot be paid due to lack of reserves.
Directors are often shocked when they are told the money they withdrew is not dividends and must be treated as a directors loan. In this
4. Benefit in kind
Benefits in kind are benefits which employees or directors receive from their employment but which are not included in their salary. They include things like company cars, private medical insurance paid for by the employer and cheap or free loans.
If you owe the company more than £10,000 at any time during the year you must treat the loan as a benefit in kind. This will mean reporting on a form P11D and paying interest and class 1a NIC on the loan.
Company cars are very common for attracting a benefit in kind. The taxable benefit is calculated on the cars fuel Co2 emissions and the availability for personal use. In most cases, it is more beneficial to use a personal car and claim mileage. These charges are in most cases not considered when starting up a company.
5. Neglecting terms, conditions and insurance
Every company when starting up should consider insurance. The type and level of cover will depend on your business. There are some key covers which you may need, these include:
- Public liability insurance
- Professional indemnity insurance
- Employers’ liability insurance
Having the right terms and conditions plus all legal basis covered from the beginning will hold you in good stead. This is, without doubt, the less sexy part of the business, but an important one. Not having the appropriate
How to overcome these pitfalls?
When starting a company or a new business venture the key is planning. Go seek layers of professional advice and educate yourself before making any rash decisions.
At Accounting Inc. we offer a free informal consolation where we will discuss your current situation and give you free expert actionable advice to take away. Our programmes will educate you and provide the support and tools to help you achieve your vision. Taking action today will stop your spiralling.
Knowing your numbers using our FD services and tools such as Xero will help you plan ahead to minimise taxes, stop pitfalls and spot opportunities.