What is a limited company?

When you start out as a contractor, one of the first things you need to decide is how you are going to structure your business, writes Lynne Gowers of contractor accountancy firm Boox, an accredited member of the Freelancer & Contractor Services Association.

One of the popular options is as a limited company. In contracting circles, the term Personal Service Company (PSC) is often used, referring to a limited company through which you supply your services.

This article is intended as a ‘limited company 101,’ although in a follow-up article for ContractorUK, we’ll also touch on alternatives ways to operate as a contractor. In this article though, we’ll address an aspect of limited company working which continues to faze even the most experienced -- IR35. 

Limited company: definition

In the most basic sense, a limited company is a type of business structure which has its own legal identity, separate from its owners (‘shareholders’) and managers (‘directors’).

Even if you are a one-person business, and you are the director and sole shareholder of the company, its assets and liabilities remain separate from your personal finances.

This legal separation between the person and the company, means directors and shareholders cannot take money out of the company whenever they want. Money coming in is owned by the company, not the individual. You can take money out of the company through a combination of a salary and dividends from the company’s available profits.

The company must file both accounts and a confirmation statement each year with Companies House, which are then in the public domain. The company must also file a Corporation Tax return with HMRC every year.

There are of course ‘pros’ and ‘cons’ to using a limited company. Let’s now drill down into these distinct positives and negatives of contracting through a limited company.

Limited company advantages

• You have ‘limited liability’ so your personal finances and assets are protected should something go wrong
• You can take advantage of certain tax efficiencies
• End-users and hirers tend to prefer dealing with limited companies, so this can increase your opportunities for work
• It is easier to sell your business because it is a separate legal and financial entity
• It may be easier to obtain start-up capital and financing to grow your business.

Limited company disadvantages

• You need to pay a fee to incorporate the business (although this can be small)
• Some people are restricted from registering a limited company – e.g. if you are an undischarged bankrupt
• Company directors have certain duties and responsibilities which come with running the company
• Details of the company, including its directors are publicly available on Companies House (although the details can be restricted to name and service address which doesn’t have to be at your home address)
• You will need to provide your own insurance
• Accounting and filing requirements are up to you, and are more complex than for other structures you can freelance or contract through.

Considering IR35

So far, we haven’t talked much about IR35, but this should probably be added to the above ‘disadvantages’ list.

It’s a rule that’s been in effect since 2000 but the government’s reform of these off-payroll working rules, scheduled from April 2020, is forcing many PSC/ ‘Ltd’ contractors to review their options. Some have moved to direct PAYE, decided to work through an umbrella company or as a sole trader.

We’ll not go into too much more detail on the IR35 changes here, as it is a huge topic in itself. You can read more in Contractor UK’s IR35 resources

However, even if your contract is caught by IR35 (known as ‘inside IR35’), you can continue to operate through your limited company and receive ‘deemed’ payments. This means that HMRC classify you as an employee for tax purposes for that assignment.

Your company income will be subject to PAYE tax and National Insurance (NI). Under the current IR35 rules (unless you are working in the public sector), you manage IR35 yourself through your limited company by you deciding whether it applies.

However, under new rules being introduced from 6th April 2020, the end-client will determine your IR35 status for tax, and deductions will be made by the party paying you, such as an agency or intermediary.

Are there ways other than a limited company to work as a contractor?

Aside from supplying your services through a limited company, there are a couple of other structures to consider. They each have their own benefits and snags but, importantly, all four are beyond the scope of IR35. We’ll explore this quartet in our follow-up article for ContractorUK, and link to it here. So quite literally, watch this space!