Ltd company tax: how it works
Limited companies are incorporated, which means they have their own legal identity and pay their own tax. Being a limited company involves a fair bit of paperwork, but there are tax advantages too.
Limited companies have their own status in the eyes of the law. Although they have shareholders (often one person), they also have legal rights, including being able to sue other companies and own assets, like their office building and even the furniture.
There are upsides to incorporating a company. The main benefit is that shareholders aren’t personally responsible for the business’s debts if things go wrong. The second is that there can be tax advantages to this kind of setup.
In short, the company pays tax and you pay tax. Let’s start with the company, and then move on to the personal side of things.
All limited companies must pay corporation tax
Corporation tax is basically a tax on a company’s profits after expenses.
Say your company has invoiced £150,000 plus VAT over the course of the year. That’s great, but those sales don’t happen by magic – the company has running costs. Maybe you’re on a salary of £45,000 and the company also claimed £25,000 in expenses. In that case, the company will pay corporation tax on the £80,000 profit.
It’s worth remembering that there are different rates of tax depending on how much profit the company makes. If it’s making less than £300,000, the current tax rate is 20%.
There’s also National Insurance and VAT
Before you hand out a staff bonus, you’ll need enough set aside to pay two other types of company tax.
National Insurance contributions
As well as corporation tax, the company has to pay National Insurance contributions (NICs) for all employees earning above a certain amount. To check the threshold for the current tax year, head over to HMRC.
Value Added Tax (VAT)
As your company grows, you might want to consider registering for Value Added Tax (VAT). In fact, you have to when you go over the VAT registration threshold. Two things you should know about VAT:
- Collecting (output tax): You’ll collect VAT from customers and pay this back to HMRC every quarter. In practice, this means adding VAT to your invoices. When the customer pays the invoice, you hang on to the tax until it’s time to send it to HMRC.
- Reclaiming (input tax): The good news is that you can also claim back the VAT that you’ve paid out to other businesses – but this figure can’t be more than the VAT you charged your customers.
And one last thing. If your taxable turnover is less than £150,000, it might make sense to register for the flat rate VAT scheme. This means spending less time with the calculator at the end of the year, as the VAT payments are a flat percentage of your turnover.
Now for your personal tax
As the owner of a business, there are two ways you can pay yourself income from a limited company – and you pay tax on both.
Pay As You Earn (PAYE)
This is your regular salary. You’ll need to pay tax on every penny you earn above your tax-free personal allowance. This is PAYE tax. That’s why it’s common for directors to cap their salary just under the personal allowance (avoiding PAYE tax), then draw the rest as dividends.
Tax on your dividends
A dividend payment is a share of company profits paid out to shareholders. As the owner (and therefore a shareholder), the benefit of paying yourself in dividends is that dividend tax is lower than the PAYE tax rate on your salary.
You can get £2,000 in dividends tax-free. After that, the rate depends on how much income tax you’re paying – which depends on what salary you’re paying yourself.
Add your dividends to your salary. Now, any dividend income that’s in:
- The basic rate tax band (starting at £11,851) is taxed at 7.5%
- The higher rate tax band (starting at £46,351) is taxed at 32.5%
- The additional rate tax band (over £150,000) is taxed at 38.1%
There’s another advantage, too. You’ll need to pay National Insurance contributions on your PAYE income (even if the company already paid NICs for you). But, there’s no NICs on your dividend income, which means no paying twice.
In a nutshell
Limited company tax might seem like a minefield, but you’ll soon get the hang of it. To recap: the company pays corporation tax, National Insurance for any employees earning over a certain amount, and VAT (if it’s registered). Then, you’ll personally owe PAYE tax and National Insurance on anything you draw as a salary (above the personal allowance), and dividend tax on the rest.