One of the first things to consider when starting out in business is the structure the business should take. There are several structures that can be adopted, and in this article, we provide an overview of the three most common: sole trader, partnership (including Limited Liability Partnerships), and limited company.
Whichever structure is chosen, it is possible to change as the business becomes established and grows. However, advice should be sought to avoid any unexpected implications of the change.
This is usually the simplest structure to adopt when starting up in business, as it is relatively inexpensive to establish and does not bring with it an onerous compliance burden.
The individual trader must register with HM Revenue and Customs as self-employed and should prepare basic annual accounts (e.g. an income and expenditure account) reflecting the trading results for the business. These accounts will form the basis of the individual’s taxable income, upon which income tax and National insurance liabilities will be calculated.
The sole trader results are reportable to HMRC via the Self-Assessment tax return. Any income tax liabilities are paid on 31 January following the end of the tax year (and on the following 31 July if payments on account are due). There is no requirement to make the financial statements publicly available (as is a requirement for a limited company or LLP, see below).
As a sole trader, there is no distinction between the business and the individual and the individual is therefore personally liable for all the business debts. This makes sole trader status commercially risky, as the personal assets and wealth of the individual could be jeopardised.
This is an extension to the sole trader structure. It is where two or more individuals are in business together and profits are shared between the partners in agreed ratios.
The partnership and the individual partners must register with HMRC and usually enter into a formal partnership agreement in which the profit-sharing ratios are agreed. A partnership tax return has to be filed annually which reports the partnership profits and the profit share allocated to each partner. The individual partners also need to file their own Self-Assessment Tax Returns in which their profit share is reported and taxed.
Although basic partnership accounts are prepared each year, there is no requirement to make these publicly available.
As for a sole trader, the profits of the partnership are taxed upon the partners individually, based upon the accounting profits. Any income tax and national insurance liabilities are those of the individual partners and not liabilities of the partnership itself.
All partners are jointly, equally and severally liable for all the partnership’s debts with each partner having unlimited exposure to liabilities. This means that each partner’s personal assets and wealth are potentially at risk if the business folds.
Limited Liability Partnership (LLP)
A limited liability partnership shares all the traits of a partnership but with one main distinction – each partner’s liability for the LLP’s debts is limited to that individual’s contribution to the LLP and any personal guarantees that have been given to secure funding for the LLP.
This limited liability comes at a cost – the LLP must file statutory financial statements with Companies House, and these accounts will therefore be available for public inspection.
The partners of the LLP will be taxed in the same way as those in a partnership, and both the LLP and the individual partners will need to register with HMRC and submit annual income tax returns. Any income tax and national insurance liabilities are those of the individual partners.
Limited Liability Company (LTD)
In general, the use of a limited company provides limitation of liability to its shareholders with each shareholder’s liability being limited to their share capital, although there are some exceptions to this limitation of liability.
In the UK, the use of a Ltd as the trading vehicle does bring with it additional compliance obligations when compared to a sole trader, partnership or LLP. Firstly, on incorporation a limited company must adopt Articles of Association (“Articles”) that govern how the company is to be run. The company can choose to have basic model Articles, as provided for free by Companies House, but often these are inflexible and more tailored Articles need to be drafted by a lawyer.
The limited company will also be required to prepare annual statutory financial statements which must be filed at Companies House. These financial statements will be available to the public and the larger the company, the greater the level of detail that must be disclosed. The names of any company shareholders who hold 25% or more of the share capital must also be disclosed.
The limited company is a separate legal entity and pays corporation tax on its profits. It must therefore prepare and submit annual corporation tax returns to HMRC.
The shareholders don’t pay income tax on the company’s profits, unless those profits are distributed to them by way of dividends. Dividends are subject to tax at dividend tax rates and must be reported on the shareholders’ personal tax returns each year.
The company shareholders may also be employees or directors of the company and will be subject to income tax and national insurances on any salaries or benefits-in-kind that may be provided to them or their families/associates by the company (e.g. company car or private medical).
Below is a comparison of the main differences, and perceived advantages and disadvantages of each of the above trading structures:
|Sole Trader||Partnership||LLP||Limited Company|
|Separate legal entity||No||No||Yes||Yes|
|Controlled by||Sole trader||Partners as governed by a partnership agreement||Members as governed by a partnership agreement||Shareholders in accordance with the Articles of Association and existing shareholders agreements|
|Limited liability for business debts||No||No||Yes||Yes|
|Self-employed||Self-employed (unless salaried/fixed profit partner)||Self-employed (unless salaried/fixed profit partner)||Yes, if employed|
|Tax on profits||Individual pays income tax and national insurance based on tax-adjusted accounting profits||Individual pays income tax and national insurance based on share of tax-adjusted accounting profits||Individual pays income tax and national insurance based on share of tax-adjusted accounting profits||Corporation tax on profits
Employees and office holders subject to PAYE and both employer’s and employees’ NIC on earnings and benefits-in-kind
Shareholders pay income tax on dividends and certain other distributions
Use of a company provides scope to manage personal income tax position
|Impact of Losses
|Can be offset against other personal income||Can be offset against other personal income||Can be offset against other personal income||Can be offset against company profits (subject to certain rules). Losses cannot be offset against individual’s income.|
|Extracting profits/cash||See above||See above||See above||Cash cannot be drawn but extracted by way of distribution, remuneration and benefits. Income tax and national insurance liabilities may arise.
Money loaned to “participators” will give rise to a corporate tax charge of 32.5% of the loan if not repaid within 9 months of the accounting year end. A benefit-in-kind arises on the individual (if an employee or director).
|No requirement to prepare formal accounts, but these should be prepared to be able to work out profits for the year. Accounts do not need to be submitted to HMRC unless HMRC request them.||No requirement to prepare formal accounts, but these should be prepared to be able to work out profits for the year. Accounts do not need to be submitted to HMRC unless HMRC request them.||Financial statements must be prepared in specified format and filed at Companies House annually.
Accounts do not need to be submitted to HMRC unless HMRC request them.
|Financial statements must be prepared in accordance with the provisions of the Companies Act.
HMRC will require iXBRL tagged accounts to be submitted with the corporation tax return.
|Other compliance||Companies must maintain statutory records which includes details of share-holders, which are available for public inspection. Annual confirmation statements to be submitted.|
Menzies LLP, accountants and business advisers based in the UK, can provide guidance on the best structure for your business and help with creating and filing the relevant documentation.
For more information, contact Rebecca Wilkinson, Business Tax Partner
+44 (0)1483 758900
Menzies is a top 20 leading firm of accountants, finance and business advisors that operate out of a network of offices across Surrey, Hampshire and London, providing our clients with easy access and local knowledge. Described as the ‘best performing firm outside of the top 10’ by Accountancy Magazine, Menzies has over 400 employees and an annual turnover of more than £40m.