Lets Points out how a company could benefit a business, and what directorship entails.
When deciding whether to incorporate a business, tax is clearly a major factor; but it is not the only one, as a company is a separate legal entity – a body corporate, and one which needs to be properly managed by its officers.
Rules and Regulations
A limited company’s constitution is contained within its ‘articles of association’, which specify the operational rules and regulations and essentially acts as a contract between the company’s owners and its directors.
Company Profits
The first thing which many sole traders or partners need to realise is that the company’s profits are the company’s and not theirs; they cannot take drawings at will. The company’s profits are subject to a separate tax (corporation tax at 19% on profits below £50,000 and 25% above £250,000), and those same monies are only further subject to personal income tax when withdrawn from the company.
How are the Profits Withdrawn?
The company’s owners (shareholders) can receive dividends by virtue of their shareholding by approval of the directors; these dividends come from the company’s post-tax profits, which make up the distributable reserves. Often different classes of shares may be issued – often known as ‘alphabet shares’ – to allow the company to pay different shareholders varying rates of dividend. However, the company’s officers (the directors and company secretary) are treated the same as employees for tax purposes, so they can receive a salary – normally a tax-deductible cost to the company and subject to PAYE and National Insurance contributions (NICs). Pension contributions can also be made, which are free from income tax and NICs on the recipients and tax-deductible for the company. Officers can pay themselves an ex officio fee but may also have an employment contract, duties from which entitle them to a larger salary and pension. If the company uses any loan capital or land belonging to the shareholders and officers, the latter can receive interest or rent respectively from the company (NB basic rate income tax must be deducted at source from interest). Loans can also be made by the company to shareholders and officers, though benefit-in-kind income tax charges on loans of or above £10,000 will apply to officers, and a 32.5% deposit (widely known as a ‘section 455 charge’) will be payable by the company and repayable when the loan is repaid or written off. Be aware that assets (e.g., land and buildings) owned by a shareholder but used by their trading company only attract 50% business property relief for inheritance tax purposes.
Who are these Officers?
This is the term for directors and company secretaries, who are registered as such with Companies House (the executive agency of the UK government which creates and dissolves limited companies and maintains the register of companies and their shareholders and officers). Directors manage (and are, effectively, agents for) the company; for smaller companies, they may also be shareholders. Besides common law duties, directors are subject to general duties under the Companies Act 2006 – these are enforceable statutory obligations to act within their powers; promote the success of the company; exercise independent judgment; exercise reasonable care, skill, and diligence; avoid conflicts of interests; not accept benefits from third parties; and declare interests in company transactions. Private companies in the UK no longer require a company secretary, but when appointed, such officers are responsible for the administration of the company (e.g., maintaining statutory books, filing annual returns to Companies House, and arranging directors’ meetings).
Practical Tip
Incorporating a company is not a decision to be made lightly; it is creating another legal person and exposing profits to another tax; this necessitates a new mindset with respect to tax and remuneration planning with the withdrawal of profits – no more helping oneself from the ATM at will! But more than tax, it involves the imposition of legal obligations on directors and more reporting and administration than sole trades or general partnerships.