Should you set up a limited company? Factors to consider in 2023

Once your business reaches a certain size, establishing a limited company can have many benefits.

A private limited company is a corporation, which means it is seen as a separate legal entity. It pays its own taxes, can own property, borrow money and sign contracts. However, the decision to register your company shouldn’t be taken lightly as there is also an increased administrative burden and tax considerations to be aware of.

See also: How does a limited company work in the UK?

IR35 explained

IR35 is a set of legislation to ensure that workers, whether on the payroll or not, are taxed fairly. This means that if a contractor works under exactly the same conditions as an employee, IR35 ensures that the contractor pays the same tax and national insurance as an employee.

Through IR35 legislation, Her Majesty's Revenue and Customs (HMRC) is cracking down on contractors working through their own limited company for the purpose of paying less tax, where the nature of the contractor's working relationship with its end client is similar to employment.

An IR35 reform, passed in April 2021 (after a one-year delay due to the pandemic), shifted the burden of assessing the IR35 status of contracts to medium and large companies from the contractor to the end client, or fee payer.

Get to know your IR35 status

Falling “inside” of IR35 means that you are taxed as an on-payroll worker and only receive a salary through your company, as opposed to a salary and dividend split.

When it comes to IR35, each project is evaluated independently. For some projects, you may fall within IR35, but for others you may not. While it’s possible to take on both contracts that fall within IR35 and without under one company, this creates a lot of hassle.

Before you consider taking on any project-based work, you should query the IR35 status of the contract with your client or agent. The status of your contract should be communicated to you by means of a status determination statement. This should be sent to you before a contract is drawn up or a rate is agreed upon, as contracts inside of IR35 tend to have a higher day rate to attempt to compensate for the increased tax implications.

In some cases, for example if your end-client is based outside of the UK or is a small business (according to Companies House’s criteria), the decision on the status of the contract will fall back to you, the contractor. Although the reform does not apply in these cases, it is still important to check the IR35 status of the contract to ensure compliance. To do this, you can use HMRC's tool, or instruct an independent company to carry out an IR35 review of your contract.

If the type of work you usually take on is likely to fall within IR35, having your own company is largely redundant and we recommend being added to your client’s payroll or working with a Financial Sector Conduct Authority (FSCA) accredited umbrella company to ensure that your payroll is carried out in accordance with the law.

As agencies become more comfortable with the reform regulations, IR35-compliant contracts are becoming more common in the market. Hopefully this is a sign that we have overcome the blanket ban that many recruitment agencies imposed on contractors when the change was first introduced.

UK corporate and dividend tax increases

Increases in corporate and dividend taxes, as well as national insurance, have been announced to make up for the deficit created by government support systems during the pandemic. The dividend tax increase and national insurance increases came into effect in April 2022 and the corporate tax reforms are to be implemented in April 2023.

From 1 April 2023, the corporate tax rate will rise from 19% to 25%. Small companies with profits between £50,000 and £250,000 will be entitled to marginal relief. Companies whose increased profits are less than £50,000 per year will continue to be taxed at 19%. 

The effects of the business tax reform

There are legitimate ways to mitigate the impact of the corporate tax increase. For example, through a salary increase or contributions to a company pension scheme, both of which are tax deductible if they meet the “wholly and exclusively for the purpose of trade” test.

The dividend tax increase was marginal. The basic rate of dividend tax was raised from 7.5% to 8.75%. This is comparable to the income tax rate of 20%. The higher dividend tax rate is currently 33.75%, while the additional tax rate is 39.35%. The tax-free allowance of £2,000 will be reduced to £1,000 from the 2023-2024 tax year, and then to £500 from the 2024-2025 tax year.

Working closely with your accountant and financial adviser can help you find the sweet spot between your salary and dividend withdrawals, making employer pension contributions or by making investments through your limited company to recognise some level of return on the business’s retained profits.

The targeted anti-avoidance rule (TAAR)

Returning to the contracting world may be risky if you previously traded through a limited company that has recently closed, as it may trigger HMRC's targeted anti-avoidance rule. If you have closed your business, either by liquidation or voluntary strike off, and as part of the closure of the business the retained profits were paid to you as a capital distribution, there is an expectation that you will not return to trade for at least two years from the date of the distribution. If you resume trading within two years, the TAAR requires that the capital treatment of the last dividend be reversed and the distribution be taxed as income.

If you have closed your business following a recent capital distribution and have now found a new role as a contractor, whether that is inside or outside IR35, operating through an umbrella company should prevent you from falling foul of TAAR.

While recent regulatory reforms and upcoming tax changes can be daunting, forming a limited company could still be the best choice for you and your business. Before making any big decisions about your business, talk to an expert you trust.

If you need help with any information regarding contracting, or contractors’ tax issues, we’d be happy to help. Get in touch with us via email or take a look at our contractor accounting services.