Tax advantages of limited companies

Liability: Avoid common mistakes to reduce bill

The north-east has a big contractor community, largely borne out of the North Sea oil and gas industry, and many freelance professionals have set up a limited company to contract out their services.

Having a limited company offers flexibility and tax advantages, but mistakes are also commonplace.

Many contractors know that, in order to keep personal tax bills down, retaining funds in thecompany is a good idea. Generally, it is better to retain anything which will take you into higher-rate tax.

For example, drawing extra funds simply to invest in a tax-free individual savings account (ISA) is counterproductive.

The largest tax- deductible expense for many contractors is the pension contributions that their company pays on their behalf. Payments reduce your corporation tax, and remove funds from your company tax efficiently into a personal fund in your own name.

Pensions have received some poor publicity in recent years, but much of this is without foundation and they should still form a cornerstone of good financial planning for many.

Anything that is retained in the limited company needs to be extracted at some point if you are to benefit from these earnings. Here are some examples of how it can be done tax efficiently:

Taking a staff position: If you cease trading through your company altogether, because you decide to take on a staff position, for example, the rules regarding shareholders in that company are more flexible. It could be possible to transfer all shares to a non-working spouse and extract all funds out in their name with no tax leakage.

Paying your spouse dividends: It is possible that, when the company was set up, it made no sense to have your spouse as a shareholder as he or she earned too much in their own right to warrant paying dividends to. If one party starts to earn less –

“Pensions should still form a cornerstone for many”

say, for example by taking a break to raise a family – the opportunity is there to add their name as a shareholder and extract funds tax-efficiently.

Working abroad: This will depend on location, but in certain countries it is possible to extract funds from a UK company with no tax charge.

Career breaks: If you decide to take a career break or have an enforced absence from work through ill-health or unemployment, retained funds can be used to provide a continuing income.

Retirement: Generally, income in retirement will be lower – allowing for the careful drip-feeding of dividends at lower rates of tax or a capital distribution using entrepreneurs’ relief. This means you can collapse the business and extract the remaining capital subject to capital gains tax at just 10%, compared with 18% for basic- rate taxpayers and 28% for higher-rate taxpayers.

Bill Saunders is a certified financial planner and head of financial planning at Acumen Financial Planning in Aberdeen.

He can be contacted on 01224 392350.