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Can you save taxes by registering as a limited company instead of being self employed?
If you are earning money in the UK, it is important for you to have a thorough understanding of the different tax brackets and systems. Being informed puts you in a position to manage your finances in the most efficient way possible.
One of the most frequently asked questions is which is better? To be employed by a company, self-employed or open a Limited company? Let’s take a closer look at the different tax rates that apply to each of these categories.
Employed (PAYE)
An employee is an individual that works under an employment contract. This contract may be permanent, part-time, flexible hours or temporary. However, the status of the employee is guaranteed (i.e. the employee is aware of the expectations and timelines of their employment with the company and is in possession of a contract with the company).
If you are currently employed and you are considering opening a Limited Company it is important to investigate whether you fall in or out of the IR35 criteria. Falling outside of the IR35 criteria means that HMRC genuinely sees you as “self-employed” or a third party providing services to the company on an ad-hoc basis. If you fall in this category you can pay yourself in a tax efficient way
Cases where people frequently fall outside of IR35:
- Locums
- Contractors
- Replacement Worker
This leads us into the next section: What is the definition of a self-employed individual?
Self-Employed Definition
There are many terms to describe a self-employed individual in the United Kingdom. Some of the most frequently used terms are: (we can link to self employed or expenses blog)
Self Employed
- Sole Proprietor
- Sole Trader
In essence, this means that you are actively running your own business without it being incorporated at the companies house (registered). When running this type of business, you can keep all your profits after paying the required tax on the profit. A big part of being a sole trader is that you are personally responsible for any losses your business may make.
Summary:
- Sole trader is not a separate legal entity
- Keep all profits after paying necessary tax rate
- Personally responsible for business losses
Limited Company Definition
A limited company is a business that is incorporated (registered) and the company has a legal identity of its own. The owners/directors are separate from the business. The limited company must have a registered office address in the United Kingdom, there must be at least one director appointed and all directors must be above 16 years old.
Summary:
- Registered Business
- Registered office address
- At least one director
- All directors over 16 years of age
There are a few exclusions of individuals that cannot open a limited company in the UK. These are listed below. If you are:
- Not a UK resident, you cannot be the sole director of a limited company. You require an individual with UK residency and UK bank account to act as a director in the UK.
- On the UK blacklist
Comparison of Tax Paid
The following section will explore the difference between tax rates when working as an employee vs. sole proprietor vs. as a sole director of a Limited Company. It is important to note that employees and sole traders fall in the same tax bracket, therefore, they pay the same tax rate depending on their income.
Limited companies have a minimum of 19% tax rate and maximum of 25% tax rate, depending on what your profits are for the year. However, if you are operating as a sole trader / sole proprietor, your tax rate will be dependent on your income bracket (basic, higher or additional). Let’s take a closer look at a comparison of the tax rates below:
Another major benefit to setting up a ltd company is that you can also claim tax returns based on expenses for your business. These expenses can range from internet expenses, phone bills and fuel. This means that you get even more money back from your tax returns. At CIGMA our clients (on average) are able to get back up to 9% with their corporate tax returns. This means our clients effectively only pay 10% tax on their income as a limited company based on a £50k profit company.
Let’s look at a case study to explain how this works in the “real world”
Case Study / Example:
John (Pseudonym) is currently working 3 jobs as a medical practitioner. He is receiving a monthly income from each job which is summarized below:
Job | Monthly Income | Annual Income |
Locum General Practitioner at a Hospital | £5,000 | £60,000 |
Private General Practitioner Appointments | £600 | £7200 |
Guest Lecturer at university | £200 | £2400 |
Total Income | £5,800 | £69,600 |
John wants to manage his money efficiently and save on paying taxes legally.
Due to the nature of John’s work, he falls outside of IR35 because of the following reasons:
- He does not have a permanent contract with any of the institutions that he is working for.
- He can be asked to cease working for the company/institution at any time without legal repercussions for the company (i.e. hospital or university).
Currently John is paying approximately 40% tax on income above £50k.
However, John speaks to a CIGMA Accountant to find out if there’s a better way to manage his financial affairs. The CIGMA Accountant suggest the following:
- Registered as a Limited Company.
- Invoice all clients (Locum Hospital, Private Clients and, University) from the Registered Company
Why Register a Limited Company?
Instead of paying 40% tax on above £50k income, John will now pay l 19% corporation tax up to £50k profit. Additionally, John will be able to claim tax returns on business expenses. These expenses include:
- Equipment (Capital Allowances)
- Machinery (Capital Allowances)
- Business vehicles, for example cars, vans, lorries (Capital Allowances)
- Research and Development (R&D) Relief
- Reliefs for creative industries (CITR) if your company makes a profit from theatre, film, television, animation or video games
- Trading losses
- The Patent Box if your company makes a profit from patented inventions.
- Relief on goodwill and other relevant assets, such as customer relationships and unregistered trade marks
- Disincorporation Relief if you’re closing your company and becoming a sole trader, ordinary business partnership or limited partnership
- Terminal, capital and property income losses
As can be seen from this example, John can save up to 21% (Most likely significantly more) by following the procedure recommended by the CIGMA Accountant.
Want to talk to a consultant to Incorporate a Company? Book a 10 minute session.
