Back in March, the introduction of the coronavirus job retention scheme (CJRS) and the self-employment income support scheme (SEISS) provided much-needed crisis support for employers and the self-employed.
While both schemes were a lifeline for thousands of business owners who had been forced to pause their operations, they left many limited company directors feeling confused about where they would fit in.
Although you might assume that running your own company puts you under the umbrella of self-employment, directors are in fact classed as employees of their company.
This means they were not eligible for SEISS, but could make a claim for a CJRS grant instead.
This was only available, however, to those who were able to furlough themselves – and it did not cover dividend income.
There are now further questions to be answered around how the job support scheme, which replaces CJRS from November, might apply to limited companies. At the moment, it’s unclear whether it will support directors at all.
Advantages of a limited company
Putting those complications aside for now, why might you decide to structure your business as a limited company to begin with?
Perhaps the main advantage of incorporating is that it separates your business and personal finances, so that your company is treated as a legal ‘person’ in its own right.
Any debts it has or losses it makes are the company’s responsibility, not yours. In comparison, a sole trader whose business fails is responsible for all of its debts, and in the worst case could risk losing personal assets like their home, possessions and savings.
That level of protection is particularly valuable at a time of economic instability, especially if your business is likely to build up a lot of debt through capital investments.
The other main draw of forming a limited company is the potential for tax efficiency. As a director, you have the option to take an income from your company as a combination of salary and dividends, while your company profits are taxed at the current corporation tax rate of 19%.
A common approach for limited company directors is to take a relatively small salary, then take the rest of your income as dividends. This is partly because you might expect your profits to fluctuate over time – the flexibility of dividends means you can pay yourself depending on how well the company is doing.
It also comes with tax advantages, allowing you to benefit from the dividend allowance, which currently stands at £2,000, and a lower tax rate for dividends. In 2020/21, this stands at 7.5% in the lowest band, compared to the 20% basic rate of income tax.
Problems with the furlough scheme for directors
For many company directors who were taking a combination of salary and dividends before the pandemic hit, this tax-efficient arrangement came with unforeseen consequences.
In its initial phase, CJRS offered 80% of an employee’s average wages up to a monthly maximum of £2,500, but only PAYE salaries were reimbursed – not dividends.
To illustrate this problem, let’s say you took a salary of £10,000 and dividends of £30,000 in the 2020/21 tax year.
That would have made you eligible for £666.67 a month in Government support when the scheme was first introduced.
A self-employed individual who took the same income could meanwhile have received the monthly maximum grant of £2,500 under SEISS.
Another problem with the CJRS for company directors was that it only offered grants for people who had been furloughed – and that meant refraining from doing any work for the business.
While there were some exceptions that allowed company directors to continue their statutory duties, stepping back from all business activities was not a realistic choice for many directors, especially if they were operating alone.
Campaign group Excluded says there are around 710,000 limited company directors who have been unable to access full support, either because they were unable to furlough themselves or could only do so in a limited capacity.
What does it mean for you?
If you’re just starting your business now, of course, all of this has little impact on you – but it might suggest the direction the Government policy could take in the future.
The gaps in COVID-19 support for directors, and other measures like the upcoming reforms to IR35 in the private sector, seem to discourage structural arrangements that are only there for the sake of tax efficiency.
There is some speculation that the Treasury might increase the dividend rate to bring it in line with income tax, and the Chancellor has also hinted at increasing the corporation tax rate to 24%. Both of these measures could make forming a company less appealing.
But that doesn’t mean there are no legitimate reasons to form a limited company. The reduced liability we mentioned earlier is a major factor to consider, alongside the added credibility that can come with company status.
On the other hand, there are downsides to forming a company that already existed before 2020, including a higher level of administrative, accounting and record-keeping responsibilities.
The right structure for your business depends on all of these factors and more, and it’s always best to seek professional advice before making a decision.
Talk to us about your business structure.