Which kind of business should I form?
I often get asked for advice by start-ups about which type of business entity they should register as. This is quite a complex decision as you need to consider the wider picture here depending on any other income you may have, the value of your personal assets and the expected business turnover for example.
The following is meant to serve as a guide only and you may want to get specific advice from an accountant depending on the complexity of your business and personal tax situation.
If you are a one-man-band then there are two options, being a sole trader or operating as a limited company. The first is the most simple set up and is quick and easy to do online.
As a sole trader, you are self-employed and are solely responsible for all profits, debts and losses related to your business. Effectively you are the business and any personal assets you have will be liable to cover any debts that the business makes. Also, in the event of your death, the business would cease trading.
As a sole trader, the profits must be taken out of the business annually. Therefore, at the end of the tax year, taxes on profits must be paid through the Self-Assessment Tax system, which are assessed along with any other personal income you have such as rent from property. This means that depending on the amount of annual profit made, being a sole trader may not be the most tax efficient option for your business.
There is a huge misconception that you cannot employ staff as a sole trader but this is not true and you are able to take on as many staff as you wish.
Limited Liability Company
The setting up and registering of a limited company is much more complicated and requires specific documents to be drawn up stipulating things like the company shareholders, their percentage share and the value of each share. After registering your business with HMRC and Companies House, you must then also register for Corporation Tax. Depending on the business, all of this can be done relatively quickly online at a small cost.
There are specific benefits of a limited company. The first is that it is a separate entity to the directors and therefore the liability is only up to the value of the company. This means any personal assets that a director may have are not liable, as with a sole trader.
The other main advantage is that there is no requirement to take out all of the profits at the end of the year, directors can receive a monthly salary as with any other employee. This allows limited companies with high profits to take out their profits in a more tax efficient way at a later date, such as in the form of dividends.
Two or more people can form a partnership and can stipulate the percentage of responsibility between each other. The set up and rules are very similar to those of a sole trader however, apply to two or more people. All partners are required to pay taxes on their annual profit under the Self-Assessment Tax system and partners’ personal assets are liable depending on the percentage responsibility they have within the business.
I hope the above has helped to clarify some of the main differences between the most common business entities. There are of course other types such as not-for-profit and Limited Liability Partnerships, which are quite specialist and are out with the scope of this post. If you would like to know more, please contact Rebus Bookkeeping on 07720910886.