You’re one of the 600,000 new businesses that start up in the UK each year. The most common question of a new business owner is what structure should I use for that business?
There are loads of options out there, but there are three main ones. Watch our video for more information.
Sole Trader
The first option is the simplest option, and that’s to be a sole trader. If you do this, you’re the business and the business is you.
There’s nothing special you need to do to start, you just go for it. All you do need to do because the HMRC know that you start your trading.
Now, the way a sole trader works is that you are the business, you sell your services or your goods. You pay your suppliers, whatever’s left at the end is yours. There’d be some tax to pay on that, but it’s all yours.
Partnership
The second option is a partnership. A partnership is a sole trader involving more than one person, it could be two people, or it could be 200 people, but it works exactly the same as a sole trader.
It’s simple and easy to get up and running. You just need to register with HMRC to let them know that you’re doing it, and then again, you and your partners are the business.
You sell your services or goods, you pay your suppliers and again what’s left at the end, the profit is split between the partners, and you pay your tax on that.
Limited Company
The third option is slightly more complex, and that’s a limited company. Now in this instance, the limited company is actually a separate legal entity to you.
The business is run through the limited company, not through you. You own shares in the company, and also, you’re usually a director of the company, so you run it, but it exists separately to you.
The limited company sells the goods and services to your customers. The limited company pays the suppliers and at the end the limited company makes a profit.
After the company has paid its taxes, it can then transfer what’s left to you either as a salary or as a dividend to the shareholders.
Tax savings
For many business owners, the choice of business structure comes down to the tax savings available.
Traditionally a limited company and its owners pay a lot less tax than a sole trader on the same amount of profits.
That’s because the owner of a limited company doesn’t usually pay any national insurance. However, the rules did change back in April, 2016, which did narrow that gap.
There are still tax savings, but they’re not as big and your profits need to be quite large before those savings outweigh the costs.
Having said that, as the owner of a limited company, you have more flexibility about the timing that you take your money out of the company through dividends and salary, and that does give you a lot more opportunity for tax planning, which ultimately reduces your tax bill.
Other options
So aside from the tax savings, what are the other differences between the structures?
Let’s make it slightly simpler and just concentrate on a sole trader and a limited company because the partnership is really just a type of sole trader.
Now the first difference is that the set up costs, every business has set up costs common across all the structures, whether that’s your website, setting up an office or a premises.
But in terms of accounts and taxation, the difference in setup costs is that with a sole trader you just get up and go.
You need to register with HMRC to let them know that you’re doing it, but aside from that, there’s nothing else.
However, with a limited company, because it’s a separate legal entity, there are some setup costs and admin in doing that.
You need to register the company with Companies House and pay them a small admin fee to do that.
You then need to register the company for taxation as well, and that could be corporation tax but also VAT and PAYE if you have employees.
Therefore, there is more time in setup and potentially costs because it often makes sense to get someone to do that for you.
The next thing tied into that is the administration of actually running those different structures as you go forward.
The sole trader, the only accounts and taxation admin bit is that the owner, i.e. you, each year needs to a personal tax return.
The personal tax return year runs every year from the 6th of April to the 5th of April, and then you get nearly 10 months until the following 31st of January, to do a tax return showing the sales, the expenses, and therefore the profits which gives the tax you need to pay to HMRC by that following 31st of January.
If you have a limited company though as the owner off that limited company, you do need to do a personal tax return.
But on top of that, the limited company needs to do its own set of accounts, and those accounts go to Companies House, the government body that looks after companies and also to HMRC.
The company also sends to HMRC its corporation tax return that again summarises its sales, its expenses, its profits, and its tax bill.
In addition, a limited company also has to file each year a confirmation statement. This is a relatively simple form that goes to Companies House confirming the name and address of the company, the name and address of the shareholders.
You will have to pay an admin fee to Companies House of £13 to do that, it’s a simple form, it’s quite cheap, but it’s one that Companies House take very, very seriously and if you don’t do it, they close your company down.
One of the biggest differences between the structures and for lot of business owners a big driver in their decision is the limitation of liability. And this is what happens if something goes wrong.
Now, now we don’t necessary want to think about this as we set up a business because it’s all happy and exciting, but you do just have to think about what could go wrong.
This could involve owing people money that you can’t pay, whether that’s your suppliers or a loan. It could involve if you mess something up in delivering a service or goods, and somebody makes a claim against you.
Now ordinarily you would try to have insurances against a lot of these things. But what happens if you’re not insured or if it’s over a debt?
Now, if you’re a sole trader, you are the business and the business is you. So, if somebody comes after you for money, they’d not just coming after the business, they’re coming after you, which means all of your personal assets are at risk whether that’s your house, car, or anything else you own.
Whereas with the limited company, somebody can only come after the assets of the company. You are separate, your house, your car, all the other stuff you own is safe.
All that is at risk for you is anything you’ve put into the company and anything the company owns.
So that can be a huge decider if you’re working in a sector where you do feel is a little bit risky. That limitation of liability, taking some of the risk away can be a huge thing and a huge factor in your decision over the structure.
Credibility
The next difference is credibility. Now, this is a funny one because it’s not correct, but when enough people believe it becomes correct.
A lot of people just feel with that limited liability company looks more credible than a sole trader to customers, to suppliers, to the outside world.
Now, it doesn’t actually make any difference, but if people start to believe it, it kind of does, and I’ve got a lot of clients who’ve ultimately actually picked a limited company because of that, because of who they’re doing business with and having limited after the name just makes them look better.
Pensions
The next difference is pensions. If you have a limited company, there are just a lot more options for your pensions.
Now I’m not a pensions expert and I don’t want to be a pensions expert, so it’s worth speaking to an independent financial advisor about that. But just be aware there are differences.
Tax
Going back to tax, one specific thing, particularly in the year one is the treatments of any losses you might make in a new business.
Now, a new business often does have a lot of setup costs, particularly for your premises, and that means you might make a small loss in the first year.
If you’re a sole trader, one advantage is you can set that loss off against any income you made from, say, your job before you started the business and actually get a tax rebate.
Whereas in the limited company you can’t do that, it’s back to that thing where the limited company’s its own separate legal entity. Its losses can only be used by the limited company, and what happens then is any loss is used against the profits the following year.
Now there is a short-term difference in year one, but it’s worth thinking about.
What if I want to close or sell the business?
The last of the differences I just want to touch is that the exit. What happens when you want to close the business or particularly if you want to sell the business.
It can be easier to sell a limited company, and that’s because it is its own entity, it’s something that could be ring-fenced. You can see what you’re selling and the buyer can see exactly what they’re buying.
If you’re sole trader, it can just be a little bit more difficult. You can still do it, but it’s just that thing of actually what exactly are you selling? What is the business? Where does it end and you start?
There are also, again, just different tax treatments of the exits on the different structures.
So those are the main differences. I hope that’s useful. The key thing is though that actually which structure you choose does depend on your circumstances and your business, and therefore it’s well worth getting proper advice before you choose.
So, if you’d like any advice, please do get in touch. I’d love to hear from you, please contact us on gr****@*********************co.uk or by phone on 0151 380 8081.