One of the most frequently asked questions by new business owners is – how are limited companies taxed?
A limited company is a distinct legal entity, and unlike sole traderships, the financial affairs of a company and its directors are completely separate.
If you are a company director, you are ultimately responsible for understanding how your business is taxed, for registering the company to pay Corporation Tax and payroll-related taxes.
With this in mind, to help you get started here is our concise summary of the various taxes that you will encounter as a company director.
1. Corporation Tax (CT)
When you incorporate a new company, you will automatically be sent an HMRC form to register to pay Corporation Tax (CT). You must do so within 3 months of commencing your trade.
Once your business is up and running, every financial year it is liable to pay Corporation Tax on the profits it has earned.
This is a tax on the profits the company has made during the year, not on its turnover; all companies, regardless of size, pay the same rate of tax.
Your accountant will submit your annual accounts data to HMRC via a CT600 form, and the directors must pay any tax owed within 9 months and a day of the company’s year-end.
The current CT rate is 19% (2019/20 tax year); the Government plans to reduce the rate to a mere 17% in 2020.
|Corporation Tax Rate||19%||19%||17% (Planned)|
You can view CT rates going back to 1971 here. By historical standards, the current rate is very low – and certainly competitive compared to our European neighbours.
2. Value Added Tax (VAT)
VAT is charged on almost all UK products but is different from other taxes as it is the company itself who collects it on behalf of HMRC, rather than the Government collecting it directly.
If your company’s annual turnover is less than £85,000, then you will not need to concern yourself with VAT. However, you can choose to pay it if you wish.
For those companies with turnover greater than £85,000, registering for VAT is compulsory.
If you do register for VAT, this can be beneficial to your company as it allows you to deduct the cost of any VAT your business incurs via day-to-day expenses. When paying VAT, you have a couple of different options with which route to take. You can take the traditional method of calculating the amount from each individual transaction or can instead apply a flat rate across all turnover.
Deciding which method to take will depend largely on the type of business you run. VAT laws are quite complex and HMRC has in-depth guides on registering and understanding exactly how much you’ll need to pay. An accountant will be able to analyse your financial profile and suggest an appropriate VAT scheme to register for.
3. National Insurance (NI)
National Insurance Contributions (NICs) are due on the salaries paid to company employees (not dividend income). They are collected by the employer and paid to HMRC monthly or quarterly.
Class 1 NICs are paid by both the employer and employees, on income higher than the prevailing minimum thresholds. You can see these percentages here.
During the 2019/20 tax year, for example, Employers’ NIC is levied at 13.8% on salaries over £166 per week. Employees’ NICs are 12% between £166-£962 per week, and at 2% over £962 per week.
Importantly, should your company be eligible, the first £3,000 of Employers’ NICs can be written off, thanks to the Employment Allowance tax incentive.
4. Income Tax (for directors and employees)
During the 2019/20 tax year, the personal allowance is £12,500 – this is the amount of income you can earn tax-free.
Above this, all employees and any directors taking a salary are required to pay varying rates of income tax depending on their overall annual income. The prevailing tax bands are basic (20%), higher (40%), and additional (45%) if you earn £150,000 or more.
Many company owners elect to pay themselves small salaries – which attract minimal levels of income tax and National Insurance. They take most of their income in the form of dividends (below).
You can view the current income tax rates here.
5. Dividend Tax (for shareholders)
You are liable to pay tax on any dividends you receive during each tax year. Since April 2016 the way dividends are taxed has changed fundamentally. Prior to this date, a system of ‘tax credits’ was used to compensate shareholders for the fact that Corporation Tax had already been paid on company profits.
The prevailing rates are 7.5% (basic), 32.5% (higher) and 38.1% (additional), according to which income tax band your dividends fall into – see the table below.
|Income Tax Band||2018/19||2019/20||Dividend Tax Rate|
|Basic||£0 - £34,500||£0 - £37,500||7.5%|
|Higher||£34,501 - £150,000||£37,501 - £150,000||32.5%|
|Additional||£150,000 or more||£150,000 or more||38.1%|
You should note that the first £2,000 of dividends are included within a so-called ‘dividend allowance’, and are not taxable. However, your overall income is not reduced by £2,000 for tax purposes – a strange, and confusing quirk in the tax system.
Don’t forget, you also get a personal allowance of £12,500 (2019/20) / £11,850 (2018/19). These dividend tax bands apply to any income you receive after the personal allowance has been taken into account.
You can read more on the Gov.UK guide to dividend tax.
Other types of tax
What can an accountant do for you?
When you first set up a limited company, your obligations as a company director may seem very onerous – particularly when it comes to understanding tax, and keeping on top of your accounting paperwork.
We highly recommend you hire an accountant who will be able to take care of all your tax concerns, and make sure you submit your paperwork and pay your company tax liabilities on time.