What Taxes Do I Pay as a Limited Company Director?
When we get people considering which is the best business model they should set up, they often ask “What taxes do I pay as a Limited Company Director?” In this guide, we look at the taxes you will encounter if you start your own Limited Company business.
Before you start up in business, one of the first decisions you need to make is which business structure to work under. The most popular options are to set up as a limited company or to work as a sole traderand both have pros and cons. It is an important decision, and one that is influenced by your personal situation and long-term plans for your business.
There are a variety of reasons why businesses or consultants may choose to operate via a limited company. For some, the potential tax benefits are the main reason why they choose to be a limited company over a sole trader
To know more about Sole Trader and Limited Company businesses, please read “What is a Sole Trader” and “What is a Limited Liability Company”
Incorporating a limited Company
Incorporating (forming) your limited company is relatively straight forward. There are just three simple steps:
- Decide who the director(s) is going to be
He is the person that will be responsible for running the company, along with the shareholders.
- Decide who the shareholder(s) is going to be
He is the person who will own the company. The directors and shareholders are often the same people in small limited companies and can be just one person.
- Register your company with the Companies House
Once you have chosen your director, you will need to get a formation agent or accounting practice to register your company with Companies House. This can usually be done within 24 hours.
What is UTR number?
A Unique Tax Reference (UTR) is a reference number assigned by HMRC to identify you as a tax payer. You should quote this number whenever you correspond with HMRC. This number is assigned automatically after the company is registered with Companies House (usually within 28 days).
If you’re a director, you will also have a personal UTR number, which relates to your personal tax affairs.
How much is Corporation Tax for a limited company?
The Corporation Tax rate for company profits for the 2020/21 and 19/20 tax year is 19% – a business with £100,000 in annual profit will pay £19,000 in Corporation Tax.
The key to making sure you pay no more Corporation Tax than you have to is to claim every allowable deduction and expense to give an accurate picture of your profits.
If you paid £5,000 for a new piece of equipment but forgot to claim the capital allowance you are entitled to, your profits may be overstated by £5,000 – so you’ll pay £950 extra in Corporation Tax. It literally pays you to stay on top of these things.
When to Pay your Corporate Tax
Your corporation tax is due no later than nine months and one day after your financial year end.
Failure to pay your corporation tax on time could result in surcharges and interest being charged to the company.
Self Assessment Tax Return
As a director of a limited company, you must submit a Self Assessment return for yourself, as well as the limited company submitting a corporate tax return for the business’ accounts.
The Self Assessment(also known as a personal tax return) is HMRC’s way of finding out how much Income Tax and National Insurance you need to pay.It must include details about all of your income from employment, dividends paid to you by your company and other sources such as rental income or sole trader income.
The return is due by 31st January each year. However, you can usually file as soon as you have your P60 from the relevant tax year and we suggest you complete your return sooner rather than later, as HMRC become virtually unreachable closer to the submission date.
PAYE and National Insurance
Directors cannot provide director services from a company. As a result payments for director services will always be subject to PAYE and national insurance.
As a UK taxpayer, each year you’ll have a Personal Allowance – any income you receive up to the Personal Allowance is free from Income Tax. In the 2019/20 and 2020/21 tax years this threshold is £12,500.
There are also National Insurance (NI) thresholds to be aware of. They’re all currently lower than the Personal Allowance and are important when setting your salary:
The Lower Earnings Limit – as long as your salary is set above this level, you’ll retain your State Pension contribution record
The National Insurance (NI) Primary threshold – as long as your salary is below this level, you won’t need to pay any employee’s NICs
The National Insurance (NI) Secondary threshold – as long as your salary is below this level, your limited company won’t need to pay any employer’s NICs
So, the aim is to set your salary at a level that is above the Lower Earnings Limit to obtain the benefits of qualifying for the state pension, but below the level where you’ll need to pay either employee or employer’s NI.
National Insurance thresholds and its affect to director’s salary
For the 2019/20 tax year, if your salary is above the National Insurance (NI) ‘Lower Earnings Limit’ (£6,136) but below the NI ‘Primary Threshold’ (£8,632), you don’t pay employee’s NICs, but you do retain your State Pension contribution record.
The situation has changed in the 2020/21 tax year as the government has announced that the Primary threshold for NI will increase to £9,500 from 6th April 2020.
The change means that for the 2020/21 tax year the NI Primary threshold will be higher than the NI Secondary threshold. The Secondary threshold is £169 per week or £8,788 per annum from 6th April 2020.
One important impact of this change is that, for the 2020/21 tax year, we’ve calculated that setting your salary at the NI Primary threshold would mean your company will need to pay Employer’s NI and your company’s profits will be reduced due to the increased salary costs. Any reduction in your company’s profits reduces the amount of dividends available to distribute to your company’s shareholders.
This means that the most tax-efficient salary for a limited company director with no other sources of taxable income for the 2020/21 tax year will usually be £732.33 per month (£8,788 for the 2020/21 tax year) which is the NI Secondary threshold amount.
Employer National Insurance Contributions
The threshold for employer NICs works in the same way as employees. For every salary amount your employee earns above the weekly National Insurance earnings threshold, the employer has to pay NICs at 13.8%. This also applies to your own director’s salary and represents another PAYE tax the company has to pay.
Tax on Dividends
If your company makes a profit, which it hopefully will, then you have two options available to you. You can either reinvest your profit into the company or take it out and pay shareholders by issuing a dividend.
The term “shareholder” simply refers to the owner(s) of the company. So, if you own and manage your limited company, you can pay yourself a dividend. This can be a tax-efficient way to take money out of your company, due to the lower personal tax paid on dividends.
Through combining dividend payments with a salary, you can ensure that you’re at optimum tax efficiency.
Dividends are tax free up to £2,000. Over £2,000, dividends are taxed at the basic rate of 7.5% up to £37,500. The higher rate of 32.5% is then applied to dividends taken between £37,501 to £150,000.
You must register for VAT if your turnover exceeds £85,000 (2020/21) in any given twelve months.
However, if your customers are also VAT registered it could be beneficial to register for VAT voluntarily before you reach this threshold.
When you register for VAT, you have two choices of schemes. The first, Standard Rate VAT, involves reclaiming VAT on every eligible item you buy or sell. The second, Flat Rate VAT, is open to businesses with an expected turnover of less than £150,000 (in the next 12 months) and was introduced to simplify the VAT system for freelancers, contractors, and small businesses.
On the Flat Rate VAT scheme, you’ll use a predetermined VAT rate based on your industry type and pay this over to HMRC. First, you add the Standard VAT rate of 20% to your sales invoice amount, then you collect the full amount from your client. Next, apply your sector percentage to this (gross) amount, which is then paid over to HMRC via a VAT return. The difference between the two rates is retained by your business (limited company) as income
You’ll need to file a VAT return every three months. If you do not file a return when it is due, you’ll incur a penalty from HMRC.
At LibabunAccountancy, we will process quarterly VAT and annual Tax returns for you and submit them to HMRC. We’ll also process your monthly payroll and submit it to HMRC-PAYE.
To discuss this, please give us a call on +44 01234 712840.
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