Company formats and business structures explained
A business' legal structure determines who makes the management
decisions, how much tax you'll pay, what records you need to keep,
who has financial liability for the business and how you raise
money. In short, make sure you register under the right structure:
get it wrong, and it could be an expensive and complicated mistake
to rectify. If you are in any doubt, speak to a solicitor for
advice.
Sole traders
- Sole traders make up a huge proportion of businesses in the UK.
They are typically self-funded, one-man enterprises working from home or
out of a van without any employees.
- Registering as a sole trader gives you the independence and
freedom to run your business how you want without red tape or
having to file accounts with Companies House. However, it does mean
you don't have the support of a partner or board of directors to
give you guidance during the tough times.
- To register as a sole trader, you must first register as
self-employed. The business owner and the business itself then
become the same legal entity - which means you are legally and
financially responsible for the business. If it runs into trouble,
so do you.
- As the business owner, you keep all the profits. You will then
pay tax and fixed-rate Class 2 and 4 National Insurance
contributions (NICs) on those profits and fill in a yearly self
assessment tax return.
- There are no directors for the business, so you make all the
management decisions. You can raise finance from bank loans or
personal assets, but you will be responsible for ensuring those
loans are paid off.
Partnerships
- Running a business can be a lonely thing to do, particularly
during the tough times. Registering as a partnership allows you to
share costs, responsibilities and risks with another person. In
return, you'll have someone to support you and help you make the
important decisions.
- Like a sole trader, all partners will need to register as
self-employed. Partners make all the management decisions without
interference from a board of directors.
- Make sure your partners are completely trustworthy: all
partners are equally financially responsible for all debts incurred
by the business. This means if the business runs into trouble,
creditors can claim personal assets from you to pay off debts, even
if those debts are incurred by another partner - and even if you
invested less than another partner.
- It's up to the partners what share of the profits they take,
but both the partnership and each individual partner will need to
fill in a self-assessment tax return and return it to HMRC. You
will be required to pay taxes on your share of the profits, as well
as Class 2 and 4 NICs.
- It's worth bearing in mind that while you can use HMRC's free
software to fill in SA tax returns for individuals, you'll have to
fill in the SA tax return for the partnership as a whole either
manually or using commercial software. It's best to seek
advice from an accountant - if you get it wrong, the business and
each of its partners will incur a fine.
Limited companies
- Limited companies and their owners are separate legal entities,
which means while you are responsible for the business, you won't
incur losses if it runs into trouble.
- Once you register a limited company, you become an employee and
a shareholder. The owners can then draw a salary as well as
dividends. Depending on how you structure this, it can be more
tax-efficient than a sole tradership, where the owners keep the
profits.
- Owners of limited companies and LLPs are not legally or
financially responsible for the partnership. If something goes
wrong, creditors can seize assets from the business but not from
its owners - unless you have secured a loan against personal
assets.
- Limited companies and must be incorporated at Companies House
and must have at least one director. You will then need to undergo
an annual audit and file your accounts with Companies House each
year.
- As a director of the company, you will pay income tax on the
salary you draw as well as being taxed on any dividends you take.
You will also pay Class 1 NICs. The company itself will be expected
to pay corporation tax of 21% if your profits are less than
£300,000 or 28% if they are more than that each year (2009 rate.
See HMRC's http://www.hmrc.gov.uk/ctsa/ct_rate_band.htm Corporation
Tax rates table for more information).
Limited liability partnerships (LLPs)
- LLPs limit the amount of liability its partners have for the
company to the amount they have invested in it - which means
creditors can only seize the business' assets, rather than
partners' personal assets, if the business runs into trouble.
- You can register as many partners as you like, but each partner
must register as self-employed and, as with an ordinary
partnership, you will have to fill out a self-assessment tax return
for the partnership as a whole, as well as for each partner.
- Unlike an ordinary partnership, an LLP must register two
designated members with Companies House. Designated members are
responsible for appointing an auditor, signing and delivering
accounts to the Registrar, notifying the registrar of changes to
the partnership, delivering the annual return and 'acting on
behalf' of the LLP if it is wound up or dissolved.
- If one of the designated members leaves, the rest of the
partners are automatically deemed to be designated members.
- LLPs and must be incorporated at Companies House, undergo an
annual audit and file their accounts with Companies House each
year.
- As a director of the company, you will pay income tax on the
salary you draw as well as being taxed on any dividends you take.
You will also pay Class 1 NICs. The company itself will be expected
to pay corporation tax of 21% if your profits are less than
£300,000 or 28% if they are more than that each year (2009 rate.
See HMRC's http://www.hmrc.gov.uk/ctsa/ct_rate_band.htm Corporation
Tax rates table for more information).
Checklist
- Decide how much responsibility you want to take for the
business. If you can afford to be financially responsible, a sole
tradership or partnership will offer more flexibility, whereas a
limited company or LLP may have tax advantages.
- Partnerships and LLPs will need to make sure they fill in a
self assessment tax return for themselves as well as for each of
the partners.
- Individual partners can fill in their SA tax returns online,
while the tax return for the business itself must be filled in
using commercial software or by hand.
FAQ
What happens if my partner leaves or dies?
If a partner dies or leaves the partnership, the business can
carry on trading but you must dissolve the partnership
immediately.
If I choose the wrong structure, how easy is it to
change?
Your solicitor should be able to help you change the structure of
the business relatively easily. However, it can be a costly
exercise - so think carefully before you decide which format to
register your business under.
How do I take on a new partner?
If you decide to take on a new partner, they need to register as
self-employed and, if you have an LPP, you'll need to register them
with Companies House. Your solicitor or accountant should be able
to advise you on the best course of action to take.
Jargon buster
Silent/sleeping partner: a sleeping or silent
partner invests money in the business but doesn't take part in its
day-to-day running. They can take a share in and pay tax on the
business' profits.
Partnership agreement: a partnership agreement is a
contract drawn up before you enter into a partner dictating how it
is run. It's designed to resolve any disagreements between
partners. Make your partnership agreement as water-tight as
possible before you enter into a partnership to prevent disputes
from breaking down the business.
Resources
- http://www.companieshouse.gov.uk/about/gbhtml/gbf1.shtml HMRC's
Company Formation guide - guidance on company formation under the
Companies Act 2006
- http://www.sra.org.uk/consumers/consumers.page Solicitors
Regulation Authority (SRA) - check up on your solicitor's
credentials, and an online directory of solicitors who can help you
decide on your business structure
-
http://www.icaew.com/index.cfm/route/158423/icaew_ga/en/Home/Institute_of_Chartered_Accountants_in_England_and_Wales
The Institute of Chartered Accountants in England and Wales - Find
a chartered accountant, and make sure they have the necessary
qualifications to help you out
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