The government is calling on new businesses to boost and drive the UK’s flagging economy, and many entrepreneurs are taking up this challenge.
Companies House figures show a steady rise in new companies being incorporated in recent years, but there are a number of important questions to be answered when starting out on your own or taking your business to the next level.
One of the first questions is: which business structure to use? Should you opt for the simplicity of a sole trader approach, form a partnership with another budding entrepreneur or register a limited company?
Here are the pros and cons of different business structures:
1. Starting out as a sole trader
A sole trader structure is the simplest. You won’t need to register with Companies House and you won’t need to pay corporation tax as well as income tax.
If you’re not running a payroll, paperwork and red tape will be greatly reduced too. Financial responsibility, however, is of course in your hands and you will have yearly tax returns to contend with, although these are often simpler than they seem.
As a sole trader you will also have legal responsibility for your business, which can leave you exposed to much greater risk than other structures. You should take out a comprehensive insurance policy to cover yourself in case something goes wrong.
2. Forming a partnership
Partnerships are often similar to a sole trader set-up – only they have more than one owner, and each can be individually liable for the business’ entire debt (if for example one walks out).
A limited liability partnership (LLP) offers more protection to individual partners, as it limits liability to what each partner has invested in the business, and it protects the other partners from the financial consequences of one partner’s negligence.
You will, however, have to register with Companies House and put certain information on the public record with them if taking this option, much like a limited company. This is because an LLP has its own legal identity, and this means that it operates for most purposes other than tax more like a limited company than a partnership.
Sole traders and partnerships can also enjoy tax savings when it comes to providing benefits in kind. For example, providing yourself with a car for business travel is likely to be far more tax efficient as a self-employed individual than arranging a company car through a limited company structure.
3. Trading through a limited company
Limited companies offer a different set-up altogether. Companies must be registered with Companies House and pay 20 per cent corporation tax on profits.
Payroll taxes (under PAYE) will also be relevant, although this is the case where you have employees in any structure. The tax cost to the employer of employing people is 13.8 per cent Class 1 National Insurance on salaries and benefits to employees.
Depending on your profits, corporation tax can offer a much more attractive rate than income tax, especially if you want to retain some of the profits in the business for re-investment. Moreover, the Chancellor has pledged to reduce corporation tax even further over the course of this parliament.
You broadly have a choice of whether to pay salary or dividends to yourself, although there are certain guidelines you should stick to.
Taxed at ten per cent up to £35,000 (total taxable income), 32.5 per cent between that and £150,000 and 42.5 per cent above £150,000, dividends can offer business owners a very tasty tax rate compared with salaries – but on the other hand, they do not qualify for pension relief, so are not tax-efficient for growing your retirement pot.
When going into business, you will need to choose a structure that reflects your financial, tax and administrative needs. For example, if freelancing for newspapers, you’re not going to want to set up a limited company when you are starting out.
Similarly, if you’re looking to raise capital to take your office catering service to the next level, a sole trader structure might not be for you.
Unfortunately though, businesses are so varied that there really is no hard and fast rule for what structure will work and it is likely that as your business grows and your aims change, its structure will need to change too.
Tim Gregory is a partner in the private wealth group at top 20 accountancy firm Saffery Champness.
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