by Rachel Craig, Rapid Formations
This decision can be tricky for first-time business owners. You want to start off on the right foot to maximise your chances of success and avoid unnecessary complications in the future. The good news is, it’s actually quite an easy decision when you understand the differences between the three most popular legal business structures of sole trader, limited company and partnership. If you have a business advisor or accountant already, perfect – talk it through with them and they will tell you which one to choose. If not, you’re more than capable of making the right decision with just a basic understanding of the benefits and drawbacks of each structure.
The sole trader structure is great for small businesses and for people who want to pay tax and National Insurance on their business income through self-employment. It’s ideal if you’re just starting out and your annual income is likely to be around £20,000. It’s incredibly simple to set up as a sole trader and your accounting and filing requirements will be minimal.
Sole traders are individuals who own and run a business alone. You cannot use this structure to set up a business with other people or sell parts of it to investors. As a sole trader, you will have to register your business with HMRC, pay Income Tax and National Insurance (classes 2 and 9) through self assessment on your earnings and file an annual tax return to report your income to HMRC. Tax and NI payments are due once a year by January 31st after the end of every tax, rather than at the time income is actually received.
If you run your business as a sole trader, you will be completely responsible for the business and its liabilities. This means you will have unlimited personal liability for debts and any legal claims brought against the business. In the eyes of the law, you are the business. However, being a sole trader does not mean you have to work on your lonesome – you are allowed to register as an employer and hire people to work for you.
The limited company structure is very popular with all sizes of businesses, even very small ones. You can set up a company on your own, or you can set one up with other people, so there’s more flexibility with this structure. Companies must be registered with Companies House, so you will have to submit an application form. However, it’s not a complicated or expensive process, and applications are usually approved on the same day.
Companies offers better tax-efficiency and tax-planning options than the sole trader structure for businesses that generate above £20,000 per year. This is because companies pay 20% Corporation Tax on their profits and you minimise your personal income by taking a salary and dividends, rather than taking it all as a salary and paying Income Tax and NI on your full income.
Another benefit is that limited companies offer limited liability protection to their owner(s) because they exist as separate legal entities. A company is essentially a legal ‘person’, which means the business itself is responsible for debts and liabilities. The owners are only responsible up to the amount they invest or guarantee to contribute. This is incredible beneficial if you will be carrying out activities that could lead to liability claims.
A limited company is also a great choice if you will be operating in a highly competitive industry. There’s a certain prestige that comes from operating through a company because they are highly regulated and monitored. The public has access to the details of all registered companies, including financial information about details about the people who control these businesses. As a result, companies are deemed more credible and held in higher regard than sole trader businesses.
One of the biggest drawbacks of company formation, however, is the level of administration you have to deal with. You will be expected to submit accounts to Companies House and HMRC every year, your record-keeping requirements will be more complex and time-consuming, you will be required to submit an annual report to Companies House to confirm the details held on public record, you have to tell Companies House and you will have to follow strict procedures when you want to remove money to pay yourself. For many businesses, however, the benefits of company formation outweigh these drawbacks.
A partnership is just as the name suggests – a business that has been set up by two or more people who work together and share the profits. There are three types of partnership structures in the UK: ‘ordinary’ partnerships, limited partnerships and limited liability partnerships (LLPs).
- Ordinary partnerships are registered with HMRC. The partners are equally responsible for running the business, and they are equally responsible for debts and liabilities. If the business cannot pay its debts, the partners are personally liable.
- Limited partnerships must be registered at Companies House. They have two types of partners: limited partners and general partners. Limited partners are only liable for debts up to the amount they invest in the business, but they do not have control over the way the partnership is managed. General partners control and manage the business but are liable for any debts the partnership is unable to pay.
- LLPs must be registered at Companies House. This is now the preferred structure for many professional services firms – solicitors, accountants, veterinarians, GPs, dentists, etc – because it provides the limited liability protection of a company whist retaining the flexibility and tax transparency of the traditional partnership structure. LLP partners are equally responsible for running the business and they are only liable for debts up to the amount the invest.
Partners in all types of partnerships are taxed as self employed, so they pay Income Tax and NI on their share of profits and file their own self-assessment tax return each year. It’s also much easier to change the internal management structure and profit distribution within a partnership than it is within a limited company. For these reasons, certain professionals choose to operate through one of these partnership structures rather than a company.
Rachel Craig is the senior content writer and editor for Rapid Formations Limited, the UK’s #1 company formation agency. An expert in her field, Rachel provides in-depth guidance and advice on UK company registration, corporate compliance and starting a new business.
Latest posts by Ken (see all)
- 3 Common Problems With Corporate Mentoring Programs (and How to Solve Them) - October 22, 2019
- Can You Make a Living Trading Forex? - October 21, 2019
- 5 Things Employees Complain Most About Their Job - October 15, 2019