Starting a new business is an exciting yet challenging time for any budding entrepreneur. But before you start consider the legal structure your business will take. The structure of your business will determine the taxes its pays, personal liability and the amount of admin involved.
Types of business structures
The main options available for structuring a business are:
There are a number advantages and disadvantages to each option. The choice you make will depend on many individual factors and future plans for the business. Below, we explore some of the key points of each.
Sole Trader
This is by far the simplest and easiest structure to set up. Once you register with HMRC, via a simple online form, you will be considered self-employed and will be required to file self assessment tax returns. As a Sole Trader you are entitled to keep all your business profits after tax. The tax you pay depends on your total income as an individual. If you’re already a higher rate tax payer, earning over £50,270, this can prove to be very expensive with tax on profits being 40% or even 45% if your total income is over £150,000. If you’re a basic rate taxpayer, within £50,270, you will pay 20% tax on profits. You may also need to make National Insurance contributions. If the business profits are now your only income then you will be entitled to the personal allowance meaning the first £12,570 of profits will be tax free.
The major downside to being a Sole Trader is that you as an individual are responsible for the businesses liabilities. This means that all personal assets, even this jointly owned, can be at risk in the event of a claim against the business.
A Sole Trader can employ staff and operate a payroll scheme to do so.
Advantages of being a sole trader
Disadvantages of being a sole trader
Partnership
A Partnership is essentially where a number of Sole Traders come together under a partnership agreement and agree to share the ownership, profits and liabilities of a business. You need at least two partners to form a partnership and there is no limit to how many partners there can be.
The partnership completes a tax return annually but does not pay tax itself. Rather each partner is responsible for declaring their share of the partnerships profits on their own tax return. Then, depending on your individual circumstances you pay tax at the appropriate rate and National Insurance contributions, if applicable, just as you would as a Sole Trader.
Risk is shared by the partners and your personal assets are still at risk just as with a Sole Trader. The partners must however appoint a ‘nominated partner’ who is responsible for the businesses record keeping and tax return filing responsibilities.
Advantages of a Partnership
Disadvantages of a Partnership
Limited Liability Partnership (LLP)
A Limited Liability Partnership is in effect the same as a Partnership with the key difference that the partners’ liability is limited to the amount of money they invest in the business. This means that personal assets are protected.
The LLP must be registered at Companies House as well as HMRC. It must also prepare annual accounts. It must also have at least two partners who are ‘designated member’ who will be responsible for record keeping and accounts filings.
Advantages of a LLP
Disadvantages of a LLP
Limited Company
A Limited Company is a separate legal entity with its own rights and obligations. This means that in legal terms it is completely separate to you. It has shareholders that own the business and directors that run the business. You can be both a shareholder and director. The director(s) are responsible for all compliance matters. This includes maintaining the statutory registers and filing annual accounts at Companies House and annual tax returns to HMRC for the company. Most for profit companies are limited by shares. This means that your liability as a shareholder is limited to your investment and any personal assets are protected.
A company does not pay Income Tax or National Insurance contributions, rather it is liable to pay Corporation Tax at 19% on any profits. Profits after tax are retained by the company, so unlike a Sole Trader the business owners are not automatically entitled to the profits. Any retained profits can be distributed to shareholders in the form of a dividend. As a shareholder receiving a dividend you are responsible for declaring and paying any taxes due. Income Tax rates payable on dividends are considerably less than those payable on earned income.
The Company can pay you a salary for your work as a director which can be set at any level. This as well as the ability to retain profits can bring about a number of tax planning opportunities.
A Limited Company must be incorporated at Companies House.
Advantages of a Limited Company
Disadvantages of a Limited Company
