PLEASE NOTE: The charity TaxAid advises only those people on low incomes whose problems cannot be resolved with HMRC.

Forming a company

Starting a new business

Some businesses will want to operate as a limited company. Indeed independent computer consultants and some other trades and professions are almost obliged to do so (see point four below for details). Tax is only part of the story and people intending to go into business for themselves should consider the following:

1.You and your company are separate. A company is a separate legal entity from you, and its money is not your money. If you don’t keep to these boundaries you could end up in a lot of trouble with the HMRC.

2. Look at the tax bills. You need to look at the total tax cost for both you and the company before deciding whether this is the best option for you. It is a complex equation and you will need professional help. Limited companies are unlikely to result in a lower tax bill overall for people on a low income.

3. Taking money out of your company. Money you take out of the company will usually be paid as either salary or dividends. You need an understanding of tax and company law to get this right – or you need to pay someone else to do the administration for you. If you use your company’s bank account to pay private bills you are likely to get into difficulties with the HMRC and what you do could even be challenged in court.

4. Providing your services through a company (sometimes called a ‘Personal Service Company’). If you have a company through which you provide services to your clients or customers, you may come within special rules for personal service companies (often referred to as ‘IR35’). These provisions defeat any tax advantages of trading as a company, as compared to being a direct employee of the organisation you are working for.  You may also be affected by the Agency legislation and Managed Service Company rules.

This is a complex area where individual details make a large difference. Special rules generally apply if the nature of the relationship between you and your client could have been considered one of employer and employee, if it were not for the existence of your company. If you think IR35, agency legislation or managed service company rules may apply to you, it would be best to take professional advice. You can find a list of the sort of occupations which can be affected and an introduction to the rules on the HMRC website at http://www.hmrc.gov.uk/ir35/occupations.htm 

The tax deductibility of travel expenses can be affected by operating through a Personal Service Company, or other ’employment intermediary’. In a tax context an ’employment intermediary’ is any person or organisation, such as an agency or umbrella company, which forms part of the chain between a worker and the business which benefits from the worker’s services.

5. Tax avoidance. Companies can sometimes enable you arrange your affairs so that you pay less tax. HMRC may challenge such arrangements. For example, if you and your spouse or partner hold shares in the company between you, and your spouse or partner doesn’t take part in earning the income of the business – yet you both take out the same amount of money from the company, then HM Revenue and Customs may challenge the arrangement, because overall, it may mean you pay less tax. This is an area where there have been differences of opinion between taxpayers and HMRC.

6. Administration. There are lots of rules about what you can and can’t do with a company. The records that you need to keep are more complex than for a partnership or sole trader. Annual accounts must be prepared in an agreed format and information submitted to Companies House. A tax return has to be completed for the company and tax paid on its profits. You will almost certainly need to pay for professional help.

7. Payroll. As you will be an employee of your own company, you need to operate a payroll. Tax and National Insurance may be due on directors’ salaries and fees. You will need to consider private use of company cars, and other benefits. Returns must be made to HMRC and your company will be fined if the returns are late. You may need to pay someone else to do the administration for you.