There are a number of different ways to set up a business, but determining which is best for you depends on a combination of factors. The following is a quick summary:
Sole Traders
This is the simplest form of business to start if you carry on business on your own account, but is generally only suitable for very small businesses.
Its main advantages are as follows:
- If ‘full’ accounts are not required, accountancy fees and other compliance costs will be kept to a bare minimum; however, once profits reach a certain level the tax savings of incorporation will outweigh any additional compliance costs.
- Losses incurred by a sole trader can be offset against other income to obtain a tax refund or deduction.
Its disadvantages are that:
- a sole trader’s liability for business debts is unlimited
- Income Tax and Class 4 National Insurance is due on all profits, whether drawn or not.
Partnership
A partnership consists of two or more persons carrying on business together, and the individuals tax liabilities are calculated in the same way as for a sole trader.
It is important to note that the partners are all jointly and severally liable for partnership debts, but each partner is solely liable for the tax and National Insurance on their share of profit.
The advantages and disadvantages of a partnership are similar to those of a sole trader.
Limited Company
A limited company is a separate legal entity from its owners and is governed by company law.
It must have at least one shareholder (shareholders own the company) and at least one director (directors are responsible for its management). Shareholders do not have to be directors, or vice versa.
Importantly, the liability of its owners for business debts is limited to the amount of any sum that is unpaid on share capital, and this will usually be nil or negligible.
A company pays Corporation Tax on its profits, and can make payments called dividends, which are free of National Insurance contributions and can therefore be a very tax efficient of rewarding shareholders.
NB. Some regulatory bodies do not allow their members to incorporate – e.g., solicitors – so they have to trade as a partnership or sole trader.
Main advantages of using a limited company
- Possibly significant tax advantages, because profits are taxed at Corporation Tax rates which are a lot lower than the higher rates of Income Tax.
- The liability of its shareholders is limited to the amount unpaid (if any) on any share capital they own – ie, in the event of company failure, a shareholder’s personal assets are protected. This may be particularly attractive for a non-director shareholder, who wishes to invest on the company but has no control over the day to day management.
- A limited company has better borrowing potential than an unincorporated business because it can use current assets as security by creating a floating charge over its assets.
- The documentation for company formation and governance is generally cheaper to produce than the equivalent for a partnership
- Changes in ownership is very flexible and straightforward to effect. Amongst other things, this will help attract investment and facilitate exit planning.
- A limited company may appear more credible and substantial (although in reality this is not necessarily the case).
Main disadvantages of using a limited company
- Your annual accounts, and other information about the company, have to be filed at Companies House and are available for public inspection (although in practice the information filed is very limited in the case of most companies).
- It can be costly and complicated to wind a company up.
- Accountancy fees can be higher than for a sole trader because as there is more paper work to deal with (although there is little difference if the sole trader or partnership requires full accounts to be prepared)
- Any losses made by the company cannot be used against the owner’s other income.
Limited Liability Partnership (LLP)
LLP’s are treated like a normal partnership for tax purposes but the members of the partnership have the protection of Limited Liability.
They are therefore a hybrid of the aforementioned business structures, but may be preferable to a general partnership or limited company in limited circumstances.
Business splitting
Finally, it is possible to split a business into two; one part running as a limited company and one as a sole trader/partnership to get the best of all worlds; however, the split must be considered very carefully to avoid falling foul of the tax authorities.
Conclusion
Take advice at the outset to try and ensure you set off on the right foot but, remember, your business structure can change as your business evolves. For example, a sole trader could take on a partner and become a partnership, or a partnership can incorporate and become a limited company. A good accountant will give you timely advice on the matter.
How We Can Help You
Advising on the most appropriate business structure for you, in terms of commercial matters and tax issues is what we do. Contact Sutton McGrath Hartley now for a free initial discussion on 01142664432 or email jburnett@smh.group
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