Becoming a Ltd Company - Can you help me clarify a few things.

[JingleMum]

Hi,

My DP has always been self employed and I found his self assessments very straight forward (I do all of his book keeping and accounts)

He has now changed from self employed to a Ltd Company and is due to see an accountant next week. I don't really know the first thing about becoming a Ltd Company but have done a little research in the spare time that I have it's baffling me

DP has just set up a new business account for his new venture and his accountant is setting is putting him on the payroll and will issue him with a wage slip every month. DP needs approx £2000 a month to live and will transfer that to his personal accountant monthly, and will then pay tax/NI on that. My question is, how do dividends work? He has to pay 20% tax on these doesn't he, so how does that work if he is withdrawing them sometimes to pay for holidays/Christmas etc? Or is he supposed to use his monthly wage from the company for all of that? What i'm asking is, if he spends say £1000 dividends every month, on top of his £2000 a month wage, then at the end of the companies trading year, he may only be left with say £1000 dividends in the bank. It doesn't seem right, it seems like you'd just spend all your dividends and not pay the tax? Can anyone clarify it for me?

Also, his business model will fail if he turns over more than £80,000 as he needs to keep it under that to avoid VAT in order to sell his products cheaper than his competitors. I will sound really stupid but I want to clarify what turnover is - is this all money that ever goes in to his business bank account? Say he spent £25,000 on stock a year and earned £50,000 is that what is classed as turnover (£50,000) or is the £75,000 classed as the turnover, even though £25,000 of it is being spent on stock?

I'm sure the turnover thing is really simple, but I can't get my head around it in relation to VAT etc. Any clarification would be appreciated.

Turnover is what comes in through the company - what he's left with after outgoings/tax is profit.

As far as dividends go, you can dividends on profit.

If you are doing the admin/books are you also on the payroll? Do you have shares in the Ltd company?

Hi Newstart i'm not on the payroll & don't have shares in the company. I'm self employed in my own right & don't have much time to dedicate to DP's business, although I seem to spend a lot of bloody time researching on his behalf

I know what turnover is in the self assessment sense, but just need to verify what it is for a Ltd Co because of the VAT situation. So if he spends 25k on stock, that's not disregarded? It's still classed as turnover because it's money he's earned that he's reinvesting?

So, you pay dividends on profit? So he needs to keep, say a monthly record of accounts that show what his profit was that month? And put 20% of that amount away every month & he's free to spend the rest? Thanks for your reply.

VAT threshold is based on sales.

He will have both a salary and then probably be eligible for dividends. You shouldn't really dividend every month. You need to have the money in the business in order to dividend. So you need to have set aside your expenses, salaries, insurance, VAT, accountant costs and an amount for corporation tax. What you are left with is available for dividends.

It is hard but not impossible to see how he could be taking £2000 a month or £24,000 out of a company that is not at the VAT threshold if he is selling physical goods and not a service. Basically he cant sell more than £83,000 in a rolling year and so his profit margin will need to be quite high. If he sells on ebay/online then postage costs are income as well, so the cost received for goods and postage cant exceed £83,000.

So if I receive £100,000 in income/sales including VAT then I have wages of £20,000, pay VAT of £14,000 (roughly), expenses of £5000, £2000 for accountant, £1000 for insurance. I have spent £20,000 on goods/materials. My total costs are £62,000 and so my profit before tax is £38,000 and I would pay corporation tax at 20% or £7600 That would leave me with £30,400 which is available as dividends or distributable reserves. I could dividend all of it, part of it or none of it. I would then be liable for personal taxation on this amount and so when it come into my account I have to set aside my personal tax.

That is a very simple overview. You dont issue dividends every month usually as they are not a salary and vary according to the distributable reserves of the company.

To add. He wont pay NI himself- that will be paid once a year through the payroll if he is a director and he will only pay NI on his salary not on dividend income. So a couple of hundred pounds a year off the top of my head.

I would suggest that you meet with the accountant as well with a view to understanding what is going on, as you clearly don't.

It is in your best interest to ensure that sufficient funds are put away each month for corporation and personal taxes, and that these are minimised as far as possible.

I'd suggest his PAYE salary should be set at approx £8k to minimise tax while still maintaining his NI contributions. Any remaining funds withdrawn are then dividends.
Taking a monthly dividend is fine, as long as there are sufficient profits in the company.

I'd recommend saving a proportion of income (turnover - i.e. sales, this is also the figure you need to consider for the VAT threshold) each month in a separate company deposit account, to cover corporation tax.
For a service based business I'd suggest 20% but a goods based business would be lower and I'd say 20% of the margin (so if you sell something for £20 which cost £5 your margin in £15).
You will have other costs which should reduce the corporation tax, but saving at these rates means you don't get caught short having to pay the tax.

You then pay income tax on your individual income, dividends are now taxed at 7.5% basic rate, 32.5% higher rate and 38.1% additional rate.
Again I'd suggest you have a separate personal savings account into which you transfer a percentage of any money drawn from the company, the percentage depending on what level of taxpayer you are.

I can't thank you enough for your detailed replies, very kind of you to take the time. I haven't got time to respond/ask further questions as I am on my way out, but I will do later on. Just wanted to thank you for the replies.

I would agree, you should both meet with the accountant.

Can I ask why he is going to be operating as a limited company? The obvious benefit is the limited liability (i.e. if someone sues him they can only take the assets of the business and not your home) but otherwise he will be paying more tax and greater fees (in particular accountancy fees).

The turnover is the money that comes into the company - you don't deduct costs.

He is unlikely to be wise taking a £2,000 salary every month. That isn't tax efficient because he will be paying both employers and employee's NI on that money. Most director employees are advised to take a salary that will enable him to get his NI stamp but not pay NI (this year its just over £8,000). Salary is deductible for corporation tax. He will pay income tax on the £8,000. He will need to operate a payroll for this via HMRC.

Once he has deducted all of his costs etc (including 20% corporation tax) then whatever is left is profit. He can either keep this profit in the business or he can declare a dividend. A dividend is just a distribution of profits to the shareholders (in this case only him).

So if he can only turnover £80k and his stock costs are in the region of £25k plus a salary of £8k and other expenses of (guessing) £2k plus accountancy fees of £1500 - £2,000 then he has a profit figure remaining of £43k.

He must pay 20% corporation tax on this of 20 percent so that's £8600

That leaves him with £34,400.

He can declare this as a dividend if he wants to (although you'd never want to strip every penny of cash out of the business).

If he declares £30,000 as a dividend he then gets taxed on this. The first £5k is zero rated. The rest will be taxed at 7.5 percent (remember he's had £8k salary). He'll therefore pay £1875 dividend tax.

So he'll be left with £28,125 total income for the year. This includes the salary. Your net monthly income will be £2343.75 on my guesstimated figures but anything else that costs him extra money like premises, insurance, equipment, telephone, broadband etc will all need to come off too (they affect the profit figure)

If you don't have other shares it would be more tax efficient to have you as a shareholder so that you also take a £5k tax free dividend.

You are all so clever! I feel so stupid.

Ok, DP saw the accountant today but I couldn't go due to work. My DP is so relaxed about it all and seems to think accountant will take care of everything and i'm worrying unnecessarily. I disagree with him and think we absolutely have to understand all the ltd co stuff inside and out.

Ok, the accountant advised he become ltd co as he said he'll pay less tax? He's been doing this line of work for a few months now and it's doing very well, so accountant said he'd be paying 40% tax if he didn't become a ltd co. The accountant has set payroll up starting from 01.11.16

Reading what you all kindly wrote I have a few more questions. I assumed corporation tax was the 20% tax on what dividends the company had at the end of the trading year. Is this not correct? If it is correct and DP was withdrawing monthly dividends, then how would he know what tax he'd need to pay on these every month? Say he withdraw £200 a month in dividends, would he put 20% of this away in a separate account for when his tax bill on dividends came in? Or have I got this all completely wrong

You say 8k a year in wages would be an idea, but my question is what would we live on? Our outgoings are far more every month than £666, so what is DP supposed to live on? This is why I was saying about him drawing dividends every month.

Thank you again for your detailed replies. I suffer with anxiety and this is causing me sleepless nights, and you are really helping me to understand things better slightly

I wish he'd just stayed self employed, I could do his books easily.

My DH recently set up as a limited company. His turnover in the first year is forecast to be about £65k. He is taking £671 a month in salary (no tax/ni to pay as below the thresholds, but enough to count for ni purposes for full future state pension).

He is also taking £2k in dividends each month - as his total income will be below £43k the first £5k won't be taxed and the rest will only be taxed at basic rate 7,5% (as the company will already have been taxed at 20% corporation tax.

He has also opted for the flat rate vat scheme as this saves him about £500 per quarter.

Happy to help more but got to go ne sorry.

As a director of a limited company he has a responsibility for the company's records, accounts and performance. I don't think airily believing the accountant will sort it all out really discharges that.

Corporation tax is 20% of the annual profit so during the year you take an estimate of what those will be and put money aside accordingly, to ensure you don't draw down more than you can afford in dividends.

When the dividend is paid, it is liable for 7.5% income tax, up to a maximum of c. £32,500.

I draw dividends monthly (albeit not the same amount every month). However, my costs are very low as it's a consultancy business.

He will pay three lots of tax

1. income tax on his small salary (you keep it small for tax efficiency reasons)
2. corporation tax on his profits currently at 20% (this is paid whether or not he pays himself dividends)
3. dividend tax on his dividends (you pay this through the tax return so once the company has declared a dividend and paid this to its shareholder (your DH) he then needs to put aside the dividend tax into a separate account so that its there waiting when his tax falls due to be paid.

1. If he tips over the VAT threshold then he'll also have vat to deal with and that's a complete PITA. Vat is paid first on everything coming in to the company.

He can take dividends monthly if he wishes IF he has made sufficient profit. The other option is using directors loans where the company lends cash to the director but I suspect if you did this you might end up in a pickle tax-wise because TBH, without meaning to sound mean, you don't really seem to understand what you're doing.

Try to get to grips with the fact that if he operates as a limited company he will be an employee plus an owner of the shares in the business. If the business makes a profit once all the businesses costs and taxes are paid then it can reward its shareholders by paying dividends. Those dividends are then taxed.

I am surprised that he will end up better off operating a limited company (to the extent that it makes it worthwhile financially). That certainly used to be the case but now the vast majority of people with lowish profit levels will be financially better off operating as self employed because in most situations the dividend tax plus the corporation tax and the cost of the accountancy work required to operate a limited company - set up costs, corporation tax returns, annual returns, income tax returns, maintaining records of dividends and drawing up board minutes and dividend certificates - will generally be greater than the tax paid as a self employed individual. In a very simplistic way it looks like he'll be loads better off because you see the 7.5 percent lower divided tax rate but remember that by the time a dividend is paid the company has already paid 20 percent corporation tax on every single penny of profit If he makes more profit that anticipated he's quickly going to hit the next band of dividend tax rate.

This is a pretty good summary article. If you have a look at the table (your DH looks like he'll have profit levels of around £40k) you'll see the difference is small (£1100) and you also need to factor in accountancy costs.

jf-financial.co.uk/2016/03/30/sole-trader-vs-limited-company-201617/

Other posters have explained profit, dividends and tax really well.

From a user point of view - I operate as a limited company, having previously been a sole trader. My situation is a bit simpler than your husband's as I don't buy stock. During the year I keep accounts of everything that goes in and out of the company bank account on a spreadsheet set up by my accountant. He showed me how to fill in the columns so everything is correctly categorised. I make sure I understand the basic financial status - it's easy to check my up-to-date turnover on the spreadsheet and get a rough idea of profit (turnover minus expenses). I pay myself lump sums from the company bank accounts when I want to, making sure I leave about a third of this year's profit to cover tax and future expenses, and entering the withdrawal amounts into the spreadsheet. When in doubt as to how much I can take out, I check with my accountant.

At the end of the year I send the spreadsheet to my accountant. He sorts out payroll and 'allocates' the money I've paid myself - some of it is listed as my £8k salary, the rest as dividends. If my income was more regular I'd plan this in advance, and take regular amounts; this would probably suit your husband better. My accountant files my accounts and tells me how much corporation tax to pay (from the company bank account). The dividends are then entered into my personal tax return, and I pay income tax on them (from my personal account).

I've found it worth the cost of having an accountant; I can leave all the year-end stuff to him, I have access to expert advice, I pay less tax than I did before. There may be other ways the switch to Ltd company could benefit your husband. When I switched from sole trader to Ltd company I sold the business to the company for X amount, which I paid tax on. This left the company owing me X. In subsequent years, this debt has been used to cover some of my withdrawals from the company, with no further tax due.

Again, huge thanks. I am struggling with this, but then again we can't know everything straight away can we. I'm sure it'll become much clearer in the end. You are really helping me to understand things better, so thanks a lot.

What's worrying me is that DP never mentioned dividend tax, which leads me to believe that either the accountant never mentioned it, or DP isn't paying enough attention...

So this dividend tax, he'll need to draw dividends as he won't be able to live on 8k a year. If he draws them monthly, say 1k a month, will he put 7.5% of that 1k in a separate account for when he declares it on his SA as a self employed income and gets a tax bill for it?

Can anyone recommend any kind of spread sheet/online account system for me to record all his income/dividends etc in?

Yes save a percentage of the dividends each month in a personal savings account.
The amount depends on his total annual income.
Basic rate (atm up to £43k) tax payers - 7.5%, above this 32.5% and higher rate (over £150k) 38.1%.

Also, make sure you save money in the company for corporation tax.

He will need to enter the dividends as income on his tax return - there is a separate section for this and he won't have any self-employed income as he is now an employee of the Ltd company.

I use Xero (cloud based accounting oackage) to record all of my DH's income/expenditure/vat etc - it's really good but you might need an accountant to help you set it up.

He has to do a board minutes and a dividend certificate whenever he declares dividend so that can act as your record.

I use YNAB for my personal budgeting/accounting and have also set it up for my business accounting too. My accountant uses Xero.

I don't think you should be trying to sort his finances out, however - he's taken this step without consulting with you and should be left to figure it out himself. Of course you need to ensure that there is enough money for the family's needs, but he will learn a great deal from the process of asking his accountant how he makes the money work. I'd be very surprised if the accountant hadn't mentioned dividend tax to him, but this is sort of the problem. You're not a director of the limited company and the discussions between him and his accountant won't involve you. The accountant will do the book-keeping in the future.

He hasn't become a ltd company. A ltd company is a separate legal entity which has been created and which he is a director and employee of. He has distinct responsibilities that can't be delegated to the accountant.

With the changes in dividend taxation and values quoted on the thread I'm amazed he was advised to go ltd!

It's possible that his field means that the limited liability is an incentive. Many professionals for example (accountants, solicitors, dentists etc) are better off operating via a limited company so that they protect their personal assets if things go wrong (even with the insurance they have to carry).

In general he will still be better off financially operating via a limited company its just that at the lower ends of the profit scale, that benefit is negligible.

If he was a high earner then a limited company would look more worthwhile.

It sounds like its worthwhile for his accountant though..