A Brief Guide To Setting Up Your Limited Company
Limited companies for contractors have long been under fire from HMRC, first via IR35 legislation, then in recent years with the changes to national insurance and VAT brought in by the current May / Hammond government. Yet for many contractors, they still remain the default model for how to run a contracting business, even if umbrella companies are catching up. In this article, we will take a look at how to set up a limited company as a new contractor, once you have made the decision to do so.
Deciding On A Limited Company.
This article looks at the structure of a limited company and the process of setting one up. It is perhaps worth briefly looking at why a contractor would opt for a limited company over being self-employed or working via an umbrella company, although this has been covered in much more detail elsewhere on this site (for more information, click here). The first thing to clear up is the difference between contractors who run their business through limited companies and are technically therefore employees, and contractors who are simply ‘self-employed.’ The self-employed contractors are inextricably linked to their business and the contractor is seen as indistinguishable from the company. Therefore they only have to fill in a tax return that shows their profit, expenses and income for the year and nothing else. The limited company contractor on the other hand operates through a more tax efficient system and has the protection of limited liability as they are more separated from the business itself – the business is taxed as a business rather than as a person. Lastly, there is the option of working through an umbrella company, which effectively manages all of the contractor’s admin and treats them as an ‘employee’ but again, sometimes lacks the tax efficiency of the limited company structure. These days, less and less contractors are using the self-employed option both because it does not offer protection when it comes to liability and also because most clients and / or agencies will only work with limited company or umbrella contractors.
Limiting Your Liability.
Most people always assume that the main reason to set up a limited company is for the tax and expenses perks. Actually, more often than not the first reason contractors will think about limited companies is because they offer limited liability to their employees / directors. Because a limited company is, in the eyes of the law, a legal entity in its own right, it is the company that will be sued in the event of a breach of contract (or perceived breach of contract) rather than any of its employees or its directors. It is for this reason also that agencies and clients will require you to have professional indemnity insurance and public liability insurance in place before you work with them (and they will set a minimum level of cover too!) As an employee of your limited company, if you are negligent somehow, it will be the company that is sued and then the insurance will be in place to pay the client suing you if necessary.
At the same time, your own personal liability is taken care of too. Limited liability allows for the liability of shareholders to be limited to the total value of their shares, in order that their own individual assets will be protected. Consequently, if a company is sued and the insurance doesn’t cover the claim, then the assets of the limited company (including any cash in the company bank accounts) can be taken, but the most the individual can lose is their own share value. And for a contractor limited company that share value can sometimes be as little as £1. The only exception to this limited liability protection comes in cases when fraud is involved or if the company was somehow set up in order to try and avoid obligations that already existed. To take one example, if you were for some reason subject to some type of restrictive covenant and then you set up a limited company in order to avoid it (referred to as lifting the veil of incorporation) then the limited liability would not count.
The Practicalities of The Limited Company
With all that in mind it is next necessary to understand the nuts and bolts of the limited company. Because it is its own legal entity, it is referred to as a ‘moral person’ in law. This defines it as having its own identity, doing business in its own name, making and losing money and paying its own taxes, as any individual person would. It also requires its own bank account as revenues must be paid to the company and not the individual. All of this explains why a limited company has to be set up in an exact way and registered (with Companies House) as if it was a new birth.
First Steps In Setting Up A Limited Company.
The first decisions you will need to make when it comes to setting up a limited company are the number of people who will be a part of the company, the name of the company and who will be part of that company. Your company will be based wherever you are and when it comes to a name it is sometimes best to choose one that is more general, so that you are not limited if your type of contracting changes in the future. When it comes to the number of people in the company, as a contractor, the chances are the company will just be you. However, if there is more than one of you, perhaps two contractors working together, then you will need to issue shares. In this example, the two contractors might decide to issue £200 of ordinary shares and they would divide them between each other, receiving £100 / 50% each. Under such an example, this division of ordinary shares would mean that dividends to be paid out would be paid proportionately according to the shareholding division. But this would only be in the case of ordinary shares. So, each would get 50% of income from dividends but that would not be the case if preferential share divisions were to be used.
The Issuing of Shares.
Other shareholders can be included into the company at your choice, but the total amount of shares issued must be proportionately divided according to the capital. Indeed it is sometimes useful to sell a single share to a third person so that if there is ever some kind of disagreement about something, they can act as a tie-breaker.
Our two aforementioned contractors are not obliged by law to issue ordinary shares. There are other types they could use, such as preferential shares which would be linked with specific rules that related to the operations of the company, though these kinds of structure are more complex and would require professional advice.
The Role of Company Secretaries.
Limited companies also are distinguished by their use of company secretaries. Although no longer required by law, company secretaries are actually valued by quite a few limited company contractors. In a public company, the company secretary is responsible for carrying out any statutory administrative duties (maintaining the statutory registers, keeping minutes and filing the annual tax returns for example). Since 2008 such a role has not been a legal requirement in a private limited company. Nowadays those same roles are more likely to be done by either the contractor themselves or by their accountant (or by their spouse who can claim an administrative salary.) However an accountant, unlike a company secretary, is not allowed to pay taxes on behalf of the company, thanks to recent Managed Service Company legislation, which is why some people still like to appoint company secretaries in their companies.
Registering With Companies House.
Once it comes to actually registering the company all you need to do is go online to the Companies House website and for a very small fee, get your company up and running. You fill out the online forms and then follow the process on screen. Companies House will then check the name you have decided on and ensure that no one else is using it and they will then ask you to appoint your director (and if necessary, company secretary.) If you don’t fancy doing it you will find that most accountants offer it as a free service when you sign on with them.
Filing A Memorandum of Association.
Next you will also be required to file something called a Memorandum of Association, again at Companies House. The Memorandum of Association is a specific document detailing the reasons that you’ve set up your company and outlining how you are planning to run it. This document is important because it can have significant legal relevance when it comes to tax disputes and in any legal proceedings which may arise. (One example of this might be in an IR35 investigation.) Contractors can write the Memorandum themselves but if they do they should keep it nice and simple. It should basically state unambiguously what the company is going to be about and how you want to run the company. However, because of the potential legal importance of the memorandum, it might be worth getting some professional advice before you submit it.
Taking Professional Advice.
If you get any aspects of the set up of the company wrong it could cause you problems in the long run so it is worth making sure everything is right from the start. And if you are really concerned you might want to think about either paying a small fee to let a company formation specialist handle your registration, or you could, as previously mentioned, use your accountant. The fee is not massive either way. A company formation expert will only cost around £100 and for that you will be able to talk through your plans for the company and set it up accordingly, using the correct structures and with the write Memorandum of Association. Similarly, your accountant will no doubt do the same for you, for free, as part of an ongoing service they offer.
Getting Your Accountant To Help.
Most accountants will do this set up free because they want to take you on as a client and be doing your taxes and payroll for many years to come. As an introductory offer they will likely have a free formation package which will consist of helping you set up the company, registering for VAT, business bank account referral and registration for corporation tax. Getting your choice of accountant right from the beginning can be extremely useful to your business so don’t just go with the first one you meet. Look for people that others have recommended and who you trust when you meet them.
Setting Up The Company Bank Account.
Again, shop around. High Street banks are not always the easiest to deal with when setting up a business bank account, so do your research online and speak to your accountant.
Getting VAT Registered.
Finally, the last bit of set-up you will need is getting your company VAT registered. Once again, this registration can be done online at the HMRC portal and indeed, dealing with your VAT thereafter is actually much easier online than doing it on paper.
And finally …
Remember to keep records of everything you do from the moment you start getting the company set up. All of the expenses you incur in setting the company up will be deductible against your future revenues, so you can start saving money straight away. And not only that, it gets you into the habit of keeping good records, something you will need to do from here on out – now you have your own limited company!