Understanding different business structures in the UK
Before we discuss the accountant’s role, let’s first look at the different types of business structures available in the UK.
1. Sole trader
Tax obligations
- Pay income tax on profits at the marginal rate.
- Contribute Class 2 and Class 4 National Insurance depending upon profits made.
- Register for VAT if your earnings exceed £85,000 annually (voluntary registration is also an option for lower earners).
Advantages:
- Easy and quick to establish.
- Lower administrative requirements compared to limited companies.
- Full retention of profits post-tax payment.
- Immediate ability to start trading, pending necessary licenses or insurance.
- Flexibility to employ staff.
- Complete operational control.
- Simpler accounting processes, with tax calculated after submitting an annual return.
Disadvantages:
- Personal liability for all business debts, risking personal assets in severe cases.
- Direct responsibility for any legal issues associated with the business.
- Lack of tax optimisation options, such as deferring profits or claiming dividends.
- Challenges in transferring ownership through inheritance or sale.
- Requirement to maintain comprehensive records of income and expenses as specified by HMRC.
2. Partnerships
Partnerships enable multiple individuals to share ownership and responsibilities in a business. All partners are jointly accountable for the business’s debts and obligations in this business structure. If a partner departs, the remaining partners assume responsibility for all existing liabilities. Profits are distributed among partners, each taxed on their share.
A partner in this business structure can be an individual or a legal entity. For detailed information on setting up a partnership, visit the HMRC guide or consult an experienced accountant.
An alternative option is a Limited Liability Partnership (LLP), which offers enhanced protection against personal liability compared to traditional partnerships. Establishing an LLP involves registration with Companies House, where essential business details are publicly documented, similar to limited companies.
An LLP must have an agreement detailing the following:
- Profit-sharing arrangements.
- Decision-making processes and necessary approvals.
- Roles and responsibilities of each member.
- Procedures for adding or removing members.
When starting a partnership, you must follow specific naming rules and have a registered address. The government provides a helpful guide that outlines the steps for setting up a limited liability partnership. Some businesses start as simple partnerships and later switch to a limited company or a limited liability partnership.
Whether you choose a simple partnership or a limited liability partnership, it’s crucial to have a partnership agreement. This agreement creates the proper legal framework for your business. You can find ready-made templates online, but seeking expert advice from an accountant is wise. Also, ensure all partners share and work together to achieve the same goals.
Advantages of a partnership:
- You share the responsibility.
- You share the risk.
- You access each partner’s skill set.
Disadvantages of a partnership:
- You lose some control over your business structure.
- If partners have conflicting business goals, it can create a challenging work environment.
- You may miss out on tax benefits that are available by incorporating.
3. Limited company
A limited company is legally separate from its owners, meaning it is responsible for its own debts. If the company fails, it does not affect the owners, provided they operate legally and honestly. Limited companies can also enhance your credibility when dealing with other businesses.
Tax obligations
Operating a limited company requires more administration and compliance with government regulations. Directors may pay the following, depending upon the profitability of the business, the income received and the way they receive their income:
- Income tax
- Dividend tax
- National Insurance
For more information about your responsibilities as a company director, visit Companies House.
The company itself must pay the following, depending upon its profitability:
- Corporation tax
- Value Added Tax is applicable if revenue exceeds £85,000 annually (registration for VAT is optional even if earnings are lower).
- National insurance contributions.
- Pensions, if you employ people.
Advantages of a limited company:
- You separate your personal and business finances, so your personal assets are protected if your business fails.
- Having a limited company can make your business look more credible to others, as it’s seen as a more serious setup and more transparent than being a sole trader.
- You can keep profits within the business, which often means paying less tax since corporation tax on profits is usually lower than income tax for individuals or partners.
- You can lower your tax bill by taking a small salary and larger dividends, which do not require National Insurance contributions.
- It may be easier to sell an incorporated business when you retire or pass away compared to a sole trader or partnership.
- You can attract outside investors through the Enterprise Investment Scheme, which offers tax breaks to those investing in small unlisted companies.
Disadvantages of a limited company:
- You must register your business and pay annual fees to Companies House.
- There is more administration and government regulation.
- Your business accounts may be complicated and costly to prepare and might require an audit, even if your income is low.
- Your business accounts will be publicly available.
- If you take a salary above £153 a week, you must make National Insurance payments as both an employer and an employee.
If you are considering starting a limited company, use the government’s step-by-step guide. There are many important factors to consider, from selecting a company secretary to identifying key control persons.
You will also need to keep records and gov.uk provides a valuable checklist. You may want to hire an accountant to help set up your company and file the accounts. You can also register for email notifications from Companies House regarding deadlines for accounts, confirmation statements, and other helpful advice.
