Operating as a limited company – a quick reminder

A large number of those limited company law firms will have transitioned from a partnership (or sole practitioner) and, whilst the 'day job’ may have remained the same, the tax issues affecting the two types of entity are completely different.

Here is a quick reminder of some of the tax aspects of limited companies that firms should be aware of.

In general terms, these rules require transactions in the company’s shares that involve employees or directors of the company to take place at market value, otherwise income tax and national insurance liabilities can arise for the seller or acquirer of the shares (and there could be a National Insurance liability for the company as well). Changes in profit sharing arrangements, as well as retirements and new partner appointments, frequently trigger these rules. Care needs to be taken to ensure unwanted tax charges arc avoided, and planning early for shareholder changes is advisable.

Companies are able to acquire their own shares (for example, where a shareholder retires and sells their shares to the company), provided the acquisition satisfies the requirements of the Companies Act. The vendor will typically pay income tax on the payment received from the company but, where certain conditions are met, the payment may be taxed as capital and subject to the more favourable capital gains tax regime. If the desired result is for the payment to be taxed as capital, it is advisable to obtain an advance tax clearance from HMRC.

Where an employee or director receives a loan that exceeds £10,000 and on which little or no interest is paid, a benefit in kind will arise that is taxable as employment income. Where a shareholder receives a loan from the company (often in the form of an overdrawn director’s loan account), there will generally be a corporation tax charge levied on the company that is repayable when the loan is cleared. The corporation tax charge is due irrespective of the amount of the loan or the payment of interest.

Where the company pays personal expenses on behalf of an employee or director, or reimburses personal expenditure, a benefit in kind will generally arise. The benefit in kind may be avoided if the payment is treated as a loan and if the individual in question is also a shareholder the loan might be cleared by declaring a dividend. In either case, the amount of expenses paid will ultimately be taxable on the individual, either as employment income or as dividend income.

Prior to 1 April 2023, the corporation tax rate was 19% regardless of the level of the company’s profits. From 1 April 2023, the rate increased to 25% for companies with profits exceeding £250,000. For companies with profits of no more than £50,000, the rate remains at 19% and, where profits fall between £50,000 and £250,000, an effective rate of 26.5% applies.

Companies are able to claim an enhanced amount of tax relief on qualifying capital expenditure incurred between 1 April 2021 and 31 March 2023, prior to the increase in the corporation tax rate described above. 

The company’s corporation tax liability is due nine months and one day after the end of the accounting period, where the taxable profit does not exceed £1.5m. For companies with taxable profits exceeding £1.5m, the liability is payable in quarterly instalments, with two payments being due within the financial year (in months seven and ten) and two payments due after the end of the year (in months 13 and 16). Where profits exceed £20m, all four instalments are due within the year. Growing practices therefore need to monitor their annual profits and plan their tax cashflow accordingly.

For corporation tax purposes, companies are associated if one company controls the other or both are under the control of the same person or group of persons. This is important for two reasons: (1) the profit limits for determining the rate of corporation tax are divided by the number of associated companies; and (2) the profit limits for determining whether quarterly instalments are required are also divided by the number of associated companies. Where practice owners have other shareholdings, it is important to determine whether any other companies are associated with the practice.

^{*The views expressed are the author’s and not ICAEW’s.}