How does tax work in a limited company?

In many ways, taxation on companies in the UK might be even simpler than personal tax.

With personal tax you have a range of allowances. The first earnings or taxable income up to £12,750 is exempt from tax. Then comes the basic rate of tax of 20% for the amount from £12,751 to£37,700. For income amounts up to £150,000 the tax rate is 40%. There is an additional tax rate of 45% for amounts above £150,000. There is a range of bands you can look up online at any time.

On top of these, there is Capital Gains tax with different rates and different allowances depending on if you’re selling assets or properties.

For a company, you don’t pay tax on the income of the company but purely on the profit. Whatever the profit is, it’s charged at the taxable rate for that company. From April 2023, the main rate of corporation tax will be 25% for companies with profits of £250,000 or more. This applies to all profits including those below £250,000. If your profit is significantly less than that, there is Small Profit rate of 19% for profits up to £50,000. The rate will taper between the 19% and 25% for profits in the margin between £50,000 and £250,000.

Again, there are different rates, but taxation is simpler in that there is no capital gains tax on the profit. If you sell an asset, it’s liable to the tax on the profit but there’s no separate capital gains tax in companies.

Now that the money is in the company and if required you have to extract it. There will then be a personal income tax liability as you extract the money. You can take out money from your company in a few different ways – as a salary or you could take it out as a bonus. In both cases you may need to pay national insurance. Most company directors tend to pay themselves up to £820 a month which allows them to take a salary on that amount and is still within the £12,750 lower tax rate band. Whatever your lower tax rate band is, the money comes in and you are not required to pay any national insurance but still get a stamp for the state pension.

Usually, dividends are a better way of taking the money. Compared to paying it personally, if you are a basic rate taxpayer and you’re only paying 20% up to the higher rate band then that’s better than paying 19% even if your company isn’t making a lot of money plus 8.75% dividends. Inevitably, taking the money out of a company is more expensive in terms of income tax even with the capital gains tax allowances.

In many ways, companies, because of their benefits of protecting your assets in the long term, are worth while considering. If you own properties though there are the issues that mortgage rates might be more expensive. However, if you have a large property portfolio, you’re almost certainly better off having it within a company because you can pay money into pensions for yourself or your children which is directly offsetting the profits of the company.

If you’re looking to take most of the income out of your company, you may not be better off with a company as far as income tax alone is concerned. If, however, the income just rolls up because you don’t need it, it’s better having it in a company.

When you also consider the IHT rules and you’re able to give your shares of your company away directly or into an Employee Benefit Trust, there are other benefits of a company within the inheritance tax as well.

This can be complex advice and experienced advice is essential.