When starting out in business, it’s important to establish your business structure.
If you feel unsure then this is something that your accountant or legal adviser will be able to discuss with you. Choosing the right type of business structure can bring protection and tax benefits.
There are a number of business structures to choose from, but the main 4 are discussed in more detail below:
This is the smallest and simplest type of company structure, typically adopted by ‘one-man-bands’.
A market stall trader or hairdresser might choose this type of company structure as it is quick and easy to set up, has little in the way of ‘red tape’ and is inexpensive.
The down-side of this company structure is that there is little distinction between the individual and the business. You personally become liable for the debts of the business should it fall on hard times.
Also, as soon as you reach circa £40,000 in profit you will begin to pay 40% tax. Sole traders are also expected to register for self-assessment tax returns and will need to file a tax return each year and pay fixed rate class 2 NIC + class 4 NIC on any profit.
Contrary to the name, sole traders can employ staff; sole trader means that you are responsible for the business, not that you work alone. Sole traders that have a turnover in excess of £82,000 per year must also register for VAT.
Where two or more people come together to run a business, a partnership may be formed to bring those parties into a legal formation.
As with the sole trader structure, partners are responsible for any losses the business makes and any charges it incurs. It is worth noting that you are responsible for losses incurred by other partners also, so be wary who you enter in partnership with.
If supplying larger businesses, their conditions may require you to incorporate before they will utilise you as a supplier. Partners share in the business’ profits and must be registered with HMRC, file a self-assessment tax return each year, paying income tax on their share of the profits as well as national insurance.
If you are earning in excess of £20,000 in profits you will be better off by registering as a limited liability company. A good partnership agreement is necessary to govern what will happen in the event of a partner leaving the business.
Additional benefits of a partnership agreements include clarifying the nature of the partnership, assignment of management duties, limiting your liability, sharing profits, removing partners and avoiding unwanted dissolution.
Limited Liability Partnerships (LLPs)
If you do not wish to be personally responsible for the losses or debts of a business you can set up a limited liability partnership. There are a minimum of 2 designated members and all partner responsibilities should be set out in a LLP agreement.
A LLP must be registered with Companies House, file an annual return and accounts with Companies House.
When the LLP is registered, Companies House will inform HMRC so there is no need to contact them separately.
Private limited company (LTD)
This is the ‘biggest’ and most complex type of business structure mentioned so far however it also provides the most security, credibility, scalability and tax benefits.
The most common formation is ‘private limited by shares’.
The limited company is an entity that is responsible for running your business. You become an employee of the entity and most likely you will appoint yourself as a director – responsible for running the company.
Any profit that is generated is owned by the company and after it pays corporation tax the company can share its profits.
Corporation tax for profits below £300,000 per year is currently just 20%. Bear in mind that although you may not be personally liable for the business’ debts, lenders may request a personal guarantee against funds: this can put your assets at risk.
With all business types you must register for VAT if the turnover will exceed £82,000 per year.
Your accountant will be able to advise on when is best to register. Our advice is, if cash flow is good, then you do not need to register for VAT until the threshold is reached. This way you will not have to pay VAT on sales but can retrospectively claim VAT against any purchases made in the last 4 years.
When or if the time comes to sell your company, the government has an entrepreneur’s relief scheme, allowing just 10% tax to be paid on capital gains up to 10m in your lifetime.
If you are thinking of starting a new business or charging your business structure, Watson Legal can provide appropriate advice alongside your accountant. For more information or to book your free 30 minute consultation, please call 01279 466910 or email email@example.com.