Congratulations, you have decided to take the plunge and set up a company!
It’s a great time to strike out on your own, in fact the UK has seen the largest year on year rise in incorporations for the second quarter since 2012, with a 3.6% increase when compared with the same period in 2019.
With that in mind it’s time to make one of your first decisions as a business owner (after choosing the name of course)… deciding on its structure. The structure can have a significant impact on the way you are protected under the law and the way you pay tax, so it’s important to consider what structure is most beneficial for YOU.
Keeping that in mind, there is no absolute ‘right’ way to structure your new enterprise, they all have positive and negative attributes. You are also not committed to the business structure you initially decide on, you can easily amend your business structure as the business grows and your needs change.
The four most common structures of business organisations are:
Sole Trader/Self Employed
A sole trader is a self-employed individual running their own business. The business is considered an extension of the individual person and isn’t a separate entity under law. Many people opt to operate as a sole trader because it is a low cost and easy way to operate your business while retaining full control over it.
The individual owns all the business assets and is entitled to keep all the profits, but is also directly responsible for the debts and other liabilities incurred by the business. Which can mean your personal assets (such as your home) could be within reach of any creditors of the business.
Miguel Calabrese, Managing Director at Blue Rocket Accounting says, “It is important to fulfil your tax obligations when running a business. Sole traders are responsible for filing their own income tax returns, or asking an accountant to file them on their behalf.
“The sole trader’s profit or loss is added together with the other income of an individual for income tax purposes. They are required to keep detailed records of all their sales and expenses and will need to complete a Self-Assessment tax return every year, paying income tax on their profits. Additionally, they will have to contribute to Class 2 and Class 4 National Insurance. The other key thing sole traders need to be aware of is ensuring they register for VAT if their turnover exceeds £85,000.”
A partnership is comprised of two or more individuals coming together to run a business, sharing both the management and the profits. It is a legal entity recognised under the law and, as such, it has rights and responsibilities in and of itself. A partnership is beneficial because it affords more options for raising finance and is easy to form, manage and run. However, it functions much like a sole trader, with the business operating as an extension of the partners.
In a standard partnership each partner shares responsibility for the business, including asset ownership and business debts. This is true of ALL the debts you have incurred, not just the ones you have entered into as a business, so it’s vital to do your due diligence and pay attention to who you choose to go into business with.
It is recommended that you have a partnership agreement created to cover:
- The authority of the partners
- The way in which profits or losses will be shared
- The rights, responsibilities and obligations of partners
Miguel Calabrese explains the tax considerations in a business partnership, “A partnership is required to file an income tax return, but it doesn’t attract a tax liability for the partnership as the profits are shared between the partners. The partners will then pay their own tax.”
Limited Liability Partnership (LLP)
Limited Liability Partnerships are similar to general Partnerships, however they are more flexible and allow for a structure where each partner's liability is limited to the amount they put into the business.
An LLP is a separate legal entity from its members, which means it is seen independently from the partners, unlike a partnership above. This means the LLP offers a liability that’s limited to assets held within the partnership if litigation is taken against the company, and offers a degree of safety towards the personal assets of the partners.
The trade-off is that the partners’ abridged/abbreviated financial statements are made available to the public.
An LLP must file accounts annually with Companies House. Additionally, the LLP must also file details of the name and address of every member with Companies House. Upon forming an LLP, the company must start to trade within a year of registration, otherwise it will be struck off.
Miguel Calabrese says, “The LLP itself is not taxed on its income or capital gains at all. Instead the members are taxed on their shares of the LLP’s profits and gains, just like a partnership.”
A limited company is a private company and a popular form of business structure that protects the owners of a company, called shareholders, by offering them ‘limited liability’. This means they have less personal financial exposure as they are only responsible for business debts up to the value of their investments, or what they guarantee to contribute to the company.
It is a separate legal entity from its owners and can enter into contracts in its own name, as such it is responsible for its own actions, finances, and liabilities. This differs from all other structures.
Setting up a limited company does incur costs and when trading the annual accounts and financial reports are required to be placed in the public domain.
Miguel Calabrese clarifies, “Limited companies must file annual tax returns with the company paying corporation tax on its income.”
There’s no denying that choosing how to structure your business is a big decision, and one with significant financial and legal implications. If you are still undecided about what choice is right for incorporating your business it would be beneficial to contact an accountant. Not only will they be able to advise you of the best company structure, they can also ensure it’s registered with the relevant tax departments, such as VAT, Corporation Tax, PAYE etc. They can ensure you don’t fall foul of your legal obligations. Find out what you can expect from your accountant here. Feel free to get in touch for a no obligation chat on 01322 555 442.
The information and data in this article was correct at the time of publishing and every attempt is made to ensure its accuracy. However, it may now be out of date or superseded. Blue Rocket Accounting make no representation or warranty of any kind regarding the content of this article and accept no responsibility or liability for any decisions made by the reader based on the information and/or data shown here.