Starting up a business and choosing your structure

The beginning of a new year may have inspired you to ‘go it alone’ and look at starting up your own business.  Whilst this prospect can create a mixture of both excitement and trepidation, one of the areas that we can guide you through is which type of structure to use and what commercial and tax matters you need to consider.

Should you set up as a sole trader, a limited company, a partnership, or something else altogether?  There’s no right or wrong answer to this and it will often depend on a wide range of factors including the type of business you intend to run, your funding and income requirements, risk profile and your long term plans.  Your business structure might also change as you grow over time.

There are three common types of business structure which we’ve outlined below along with some of the potential advantages and disadvantages.

Sole trader

Setting up as a sole trader is perhaps the simplest way to set up and run a business as from a tax perspective you just need to register for self-employment with HMRC to pay tax through self-assessment. 

You have certain accounting responsibilities – you’ll need to keep records of your business’s sales and expenses and file a self-assessment tax return by 31 January each year. If your turnover exceeds £85,000 you’ll also need to register for VAT.  You may also want to consider voluntarily registering for VAT if this is considered advantageous.

Contrary to the name, sole traders can employ staff or hire subcontractors, so the business may consist of more than one person.  But as the business owner, you’re solely responsible for running the business and meeting your legal requirements.  If you are working in the construction industry you might need to register under the CIS scheme.

With this structure, there’s no distinction between your finances and the business’s.  This keeps things simple, but it also means you’re liable for any losses your business makes.  Trading losses may be available to offset against your other income and reduce your tax liability.

Advantages:

  • Low-cost and easy setup
  • Relatively few accounting responsibilities
  • You have full control over business decisions

Disadvantages:

  • Unlimited personal liability for business debts
  • May be difficult to secure funding or attract certain clients

Partnership

A standard partnership works in a similar way to a sole trader business, but two or more people work together and share responsibility for the business.  In a general partnership every partner is jointly and personally liable for all the business debts.

When you set up in partnership, you’ll need to register with HMRC and choose a trading name and nominated partner who will take responsibility for dealing with HMRC.  The partnership will need to submit a partnership tax return by 31 January each year.  Each partner will also need to register as self-employed and complete their own self-assessment tax returns as individuals.

It is strongly recommended that you draw up a written agreement, outlining how liabilities and ownership will work in the partnership, how you’ll split the profits, and what happens if one of you wants to leave.  Without a partnership agreement the partnership will be deemed to operate under the ‘Partnership Act 1890’ which can result in unwanted and unintended consequences!

Advantages:

  • Easy setup
  • Relatively few accounting responsibilities
  • Ideal if you want to run the business with other people

Disadvantages:

  • Full liability for business debts
  • You don’t have complete control – decisions have to be made between partners although the partnership agreement may vary rights accordingly
  • Partnership disagreements may pose a risk to the business especially if there is no partnership agreement

Alternatively, you could choose to set up a limited liability partnership (LLP).  An LLP is incorporated in the same way as a company so provides limited liability but, provided the LLP carries on an activity with a view to generating profits, they are taxed in the same way as a general partnership.

Limited company

When you set up a limited company, you’re establishing your business as a separate entity from yourself.  This means you won’t be personally liable for all of the business’s debts, as the company’s finances are separate from your own.

You will need to incorporate the company at Companies House and appoint directors.  The initial shareholders will subscribe for shares.  The shareholders are generally only liable for debts up to the amount they originally invested in the company. 

As a director, you’ll be responsible for running the company on behalf of the shareholders – although you can both be a director and a shareholder.  You’ll also have certain record-keeping, administrative and accounting responsibilities.

The company will need to file accounts which are prepared in accordance with specific accounting rules.  Accounts filed with Companies House are publicly available.  The company must also file a confirmation statement each year and ensure that it meets the requirements of the Companies Act.

Your company will need to register for corporation tax and notify HMRC of its commencement.  Corporation tax is currently paid on profits at a rate of 19%.  As the company itself has its own tax regime, you’ll need to carefully consider how best to extract those profits personally if you want to receive an income therefrom.  The extraction of profits may be structured in various ways and this can present opportunities to ensure your tax position is as efficient as possible.

Advantages:

  • Limited liability, meaning lower personal financial risk
  • May have tax advantages although this depends upon the specific facts
  • Professional image

Disadvantages:

  • Some setup costs
  • More complex accounting and admin responsibilities
  • Not as much privacy – annual accounts and financial reports are placed in public domain

The choice of business structure is an important decision and all the relevant facts need to be considered to determine what is best for you.  If you’d like to learn more then give us a call on 01892 507288 and we’d be happy to help.

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