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How to set up your company for tax efficiency

We have written this easy-to-follow guide to setting up a small limited company for one or two directors. Please contact us if you have any questions.

Company Formation

There are many companies who offer company formation services. Ensure that you form a company that is capable of trading (not a dormant company) and that you adopt and receive a copy of the standard Articles of Association per Table A of Companies Act. You should also receive a hard copy of your incorporation certificate as many banks won’t accept a printed electronic copy when setting up the company bank account.

Formation of the company should cost between £18 and £55 plus VAT (depending on the number of printed copies required etc.) or 2 -3 times the cost if you want somebody to do the work for you.

Share holdings

You can form a company with as little as 1 share (there is no maximum). However, you are meant to pay for the shares so theoretically by issuing yourself 1,000,000 shares at £1 each, you owe the company £1,000,000. Most companies start off with 1, 10 or 100 shares.

If you are the sole shareholder you can receive all the distributable profits of the company.

If you have a partner, you may wish for them to share in the profits. However, by issuing shares to them, they are entitled to profits and control of the company. These shares can not be revoked and it can be difficult (if not impossible) to rearrange the company and its assets in the event of a breakdown in your relationship.

If you are married to your partner, you can transfer shares without any capital gains implication at any time. However, if you transfer shares to your unmarried partner you may trigger a capital gains charge.

There are other considerations in transferring shares of a company with value that can trigger undesirable effects of settlement legislation so it is best to set up a company’s shareholdings correctly from the beginning.

Payroll

You should set up a PAYE scheme and make your self an employee. Ideally, you should pay yourself at a level around the Earning Threshold for National Insurance Contributions (£641 per month for 2013/14).

At this rate you will receive National Insurance credits but neither you nor your company will have to pay any National Insurance Contributions (currently this is 12% for you and 13.8% for your company on earnings above the earning threshold).

You can also put your partner and other family members on the payroll (preferably up to a similar rate as advised above providing their salary is commercially justifiable).

Using a monthly payroll is a good way of getting regular money out the company without declaring a dividend but you will have to follow strict PAYE legislation for reporting otherwise you will be charged penalties.

Dividends

Dividends are a distribution of post tax profits. You MUST leave enough profit in the company to pay the corporation tax. Therefore if you earn £50,000 in taxable profits, you must leave £10,000 (20%) to pay the Corporation Tax. Therefore only £40,000 is available for distribution.

You don’t have to wait until the end of the year to pay dividends, but you must be confident that the amount you are paying in a dividend is no more than your profit to date after a deduction for 20% tax.

You should also avoid paying a dividend every month for the same amount, as this tends to give the impression of a salary and if you slip up with other things (such as not completing dividend vouchers), it may be difficult to prove that this is not a salary (which would be a costly mistake).

A company can pay interim dividends and final dividends. There is no restriction on the number of dividends which can be paid in a year however it is important to be certain which type of dividend (i.e. interim or final) is being voted and follow the correct procedure (i.e. interim dividends require a directors’ resolution only whereas final dividends require a directors’ and shareholders’ resolutions .

Failure to follow the correct procedure can result in a dividend being treated as salary, thus resulting in additional tax & national insurance contributions

Other ways of extracting profits

There are other ways to extract profits from the company that are useful and/or tax efficient, some of the more popular methods are listed below. Many of these are tax neutral (i.e. you are taxed personally at 20% as a basic rate taxpayer and the company saves tax at 20%). However, your cash flow may improve and maybe you can reduce your dividend payments to quarterly rather than monthly payments (best practice)

 

  • Charge your company for office rent at your own house. This must be done correctly to avoid losing the Capital Gains TAX Exemption on your own house
  • Ensure that the company pays you back for your expenses, such as use of your own car
  • Transfer your mobile phone into the company name and get the company to pay the bill
  • Look to add members of your family on to the company’s payroll
  • Charge the company interest for loans to the company

 

Below is a useful summary of potential structures for Limited Companies:

Specimen Structure for one person limited company

Sole director

Partner or trusted friend/family member as Company Secretary (this person can sign things on the company’s behalf if you are unavailable)

1 share issued

Salary paid at the NIC Earning Threshold (£641 in 2013/14)

Transfer mobile into Company Name

Company rents office space in house including coffee/tea/heat/light etc at £250-£300 per month. THIS IS TAXABLE AS RENTAL INCOME FOR THE JOINT HOUSE OWNERS BUT EXPENSES CAN BE CLAIMED

Monthly claim for use of own car at 45p per mile

Dividend payment quarterly (once you make it through the first quarter, this is the same as if you paid it monthly).

 

Specimen Structure for Husband and Wife company

Two directors

2 shares issued

Salary paid at the NIC Earning Threshold for each director (£641 in 2013/14)

Transfer two mobiles into Company Name

Company rents office space in house including coffee/tea/heat/light etc at £500 – £600 per month for two offices. THIS IS TAXABLE AS RENTAL INCOME FOR THE JOINT HOUSE OWNERS BUT EXPENSES CAN BE CLAIMED

Monthly claim for use of own car at 45p per mile

Dividend payment quarterly (once you make it through the first quarter, this is the same as if you paid it monthly).

 

This article is meant as guidance only and we can’t stress enough that you should seek professional advice from a qualified accountant before setting your company up or as soon as possible if you have already set it up!

Please do not hesitate to contact us for any assistance.

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