Starting your own business should be an exciting, if exhausting, time. Once you’ve taken the decision to go solo, work for yourself, become your own boss and set up in business, the next question is: what exactly are you going to be?
You may want to call yourself a freelance contractor, independent consultant or a business director, but what your accountant and the tax authorities need to know is the legal structure you have decided to operate from.
If you’re not sure about which business structure is the right one for your business, we recommend that you get some in-depth business advice from a reputable accountancy firm that specialises in business start-ups, and take your time to discuss the advantages and disadvantages for your business in terms of day-to-day management, taxation and compliance issues.
Briefly, these are the four main legal structures to consider.
- Sole Trader
As a sole trader, you can start working straight away, without the need to register your business. You are fully in control of all your business activities, entitled to receive an income and responsible for any debts owed. As a self-employed individual, you are the business.
Profits are taxed as income by HMRC and are declared on your annual self-assessment tax return. You need to be registered as self-employed for tax reasons but there is no requirement to publish annual accounts or produce any other documentation other than that required for tax (including VAT, if you qualify) purposes. You have to pay tax and National Insurance Contributions.
Because you, as the entrepreneur, are fully liable for the business, your personal assets may be at risk if you cannot pay your debts or your business goes bankrupt.
Partnerships are similar to the sole trader structure, except that they have more than one owner. In effect, it is two or more sole traders working together, with all partners being self-employed and taxed through the self-assessment process.
Typically, a partnership agreement is drawn up between you, which will specify who owns what percentage of the business (and its profits or liabilities). As with sole traders, liability is unlimited, meaning the partners are jointly and severally liable for all business debts.
- Limited Company
If you want to convey a more professional image of your business, certainly in the eyes of your customers and suppliers, you may be considering forming a limited company. If you do, the company you found will represent a separate legal entity. Upon incorporation and registration at Companies House, the company will have standard legal documents to determine what business it operates in and what it can do. This separation of the liabilities from company ownership reduces the financial risk to you if things should go wrong.
A company can be owned by one or more shareholders, and it is the directors’ responsibility to run the company in accordance with all relevant laws and regulations. A director shareholder can draw an annual salary, and dividends are paid after corporation tax has been deducted.
As a limited company, there is considerable flexibility when it comes to taxation, compared to sole traders, due to the ability to receive an income from both salary and dividends.
However, the downside of running a limited company is the ongoing compliance burden – annual filing of statutory company accounts with Company House, corporation tax returns and confirming company directors and shareholders. This is where the ongoing services of an experienced accountant can be invaluable.
- Limited Liability Partnership (LLP)
An LLP combines the benefits of a partnership with that of a limited company and is the preferred business structure for professional services firms, such as architects, accountants and solicitors. It is a hybrid structure that combines the benefit of a limited liability with the favourable tax treatment given to partnerships.
LLPs must be incorporated at Companies House, and are also required to submit annual accounts.
Similar to a limited company, an LLP is a separate legal entity that can enter into contracts under its own name. The business can have two or more partners, with profit entitlements agreed between them. Unlike a limited company, however, each member of an LLP is considered self-employed and taxed accordingly.
This article was provided to The Money Guy by Mike James, an independent content writer working together with Surrey-based Chartered Accountants Wellden Turnbull, who were consulted over the information contained in this post.