Running a limited company can be a complicated business. A company is a legal entity and the law makes many demands on the company itself and those who run it. However, there are benefits which arise from the separate legal personality of the company in certain circumstances, which explains why many companies are formed.
The two main benefits which can arise from the company's legal personality are tax benefits and the benefits of limited liability.
The tax benefits can arise from the fact that the company is subject to its own special tax rules. If a business is carried on by a sole trader, he pays income tax on any profits, and capital gains tax on capital gains. The rule is exactly the same in a partnership in that the partners' profits and gains are charged to income and capital gains tax in separate assessments. However, a company which carries on business pays only one tax, on both profits and gains. This tax is called 'corporation tax'.
The rates of income and capital gains tax and the rates of corporation tax are different and the profits and gains which are subject to tax are also worked out differently. The taxes are also assessed and payable at different times.
The amount of profit which directors and shareholders wish to distribute from the company is also relevant when comparing the tax bill. Profits and gains which are taxed to corporation tax going into the company can also be taxed to income tax coming out of it, and into the pockets of its directors (as remuneration) and shareholders (as dividends), so the comparison between the two circumstances is more complicated than it first appears.
However, the general result of the differences between the two tax regimes is that the more profitable a business becomes, the more likely it is that corporation tax rules will produce a lower overall tax bill than the income and capital gains tax rules.
This is why a business often begins by being owned by a sole trader or partners but, when it grows larger, is transferred by them to a company formed for that purpose.
Limited liability means that, in the case of a company whose business is not doing well, and is getting into financial difficulties, the shareholders of the company are not obliged to help the company pay its debts and discharge its liabilities. It is the company which has the debts and liabilities, not its shareholders. The shareholders do of course, have to pay the company any money owing in respect of their shares. However if the shares are fully paid for (and, in the case of a private company, they invariably are), no further money is payable by the shareholders under company law. In these circumstances, the liability of each shareholder for the debts of the company is said to be limited to the amount outstanding (if any) on his shares, in legal jargon, the shareholders have limited liability.
There are other benefits to forming a limited company, including: separation of control and management, introduction of new participants, raising capital, groups of companies, status and borrowing.
About the author
has been a solicitor for 29 years, specialising in company and related law for private limited companies. David is also a qualified marketer, and his career includes profitable spells as Marketing Director of a market-leading legal services company, as well as twice setting up and running his own small business. He combines technical competence in company law with in-depth understanding of small and medium-sized businesses.
These issues are discussed in more detail along with all the essential information required for establishing and managing a limited company, in the book Running a Limited Company
, by David Impey and Nick Montague.