Being in business can be a difficult decision to make, and part of that decision making process is to decide in what format the business should be.
The main options for someone starting out (or even an existing business considering making changes) are:
Sole trader
Partnership
Limited liability partnership
Limited company
Sole trader
Generally this is the easiest and cheapest way to start a business. The set up is fairly simple - you’ll need to open up a business bank account, register with HM Revenue & Customs for taxes, arrange insurances, design a website etc.
At that point you are pretty much up and running, any profits generated are yours personally and so you can take drawings throughout the year.
You’ll need to file a Self Assessment Tax Return once a year and pay any taxes due by 31 January following the end of the tax year. Potentially you may have to make payments on account in the following July.
The major downside being a sole trader is that you are personally liable for any debts of the business. So if things go wrong, your personal assets and home could be at risk.
Partnership
A partnership has all the characteristics of a sole trader except the fact that there is more than one of you.
Tax and accounting works broadly the same way, except there will be a Self Assessment Tax Return for the partnership as well as the partners individually.
Personal assets will still be at risk, as well as a joint and several liability.
Limited liability partnerships (LLPs)
An LLP is a limited liability partnership, which for tax purposes is taxed as a partnership subject to some additional rules, but the partners liabilities are limited. LLPs are quite popular for professional firms as they are much less restrictive on ownership changes than limited companies.
However generally they aren’t popular for most trading businesses.
Limited company
When you form a limited company, it is a separate legal entity and so it is the company that makes any profits as opposed to you personally.
You are rewarded for your efforts as a Director and/or Shareholder - those rewards are typically salaries, dividends, pension contributions etc.
The shareholders liability to the company is limited to the share capital. This would typically be 100 or 1,000 £1 shares. So ultimately your liability might be £100 or £1,000 so you can see this offers much more protection.
It is important to note that if you give a Personal Guarantee, then the limited liability does not apply to that particular debt. Therefore if the company came into financial difficulties, you would be required to meet that debt personally.
If you chose to trade through a limited company, then the company will need to be formed. This is a relatively straightforward process, where the name, registered office, directors, shareholders, persons with significant control etc are registered with Companies House.
Once the application has been approved, you will need to set up a bank account in the company name. The company will be allocated a corporation tax reference number.
As mentioned above, as the company makes the profits, you may wish to register a PAYE scheme to pay yourself a salary. Once the PAYE reference number has been issued you’ll need to file the salary payments to HM Revenue & Customs. Generally we would suggest a monthly pay date rather than weekly, as it’s a lot fewer submissions to make!
The company will pay corporation tax on its profits, corporation tax is payable 9 months after the accounting year end date.
Historically there used to be quite a difference in the tax rates between being a sole trader/partnership and a limited company however these days due to the varying rates of corporation tax there probably isn’t much in the headline tax charge.
We tend to suggest to clients to think about the following as much as tax:
Limited liability
Credibility to customers
Data at Companies House available for the public to see
The ability to influence the timing of income personally (sometimes deferring income can make a huge difference to your tax position and/or child benefit claim)
As mentioned at the start, it isn’t a decision just for those starting out, someone who is currently in business may want to consider whether they are using the right entity for their business.
Please get in touch if you’d like some advice.
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