When starting up a business one of the first things you need to do is to decide the right legal type of business. It is worth thinking carefully about which structure best suits your business needs, as this will affect your income tax and National Insurance payment obligations, the work with records and accounts and your financial liability if the business runs into trouble. Each legal type of business could bring several advantages and disadvantages therefore you should consult a professional before deciding on the type of business you will have.
SOLE TRADER (SELF-EMPLOYED)
Being a sole trader is the simplest way to run a business – there are no registration fees to pay, keeping records and accounts is straightforward and easy, and you get to keep all the profits after tax. A sole trader can start trading almost immediately. However, there are also some disadvantages. A sole trader is personally liable for any debts that the business runs up, which makes this a risky option for business ideas that need a lot of investment. It can also be difficult to obtain capital to expand the business. In addition, a sole trader, as a self-employed person, is entitled to fewer social security benefits than an employee.
A sole trader must register as a self-employed person with HM Revenue & Customs. In case the sole trader assumes that the business’ turnover would reach £83,000 (level required for compulsory VAT registration) for a 12-month period then it is also needed to register for VAT. You cannot be a sole trader in the UK unless you are a UK resident with a National Insurance Number.
Tax responsibilities
You must:
- send a Self-Assessment Tax return every year
- pay Income Tax on the profits your business makes
- pay National Insurance
LIMITED PARTNERSHIP (LP)
In a limited partnership, two or more people share the risks, costs and responsibilities of being in business. Each partner has to register as self-employed and takes a share of the profits. Usually, each partner is personally responsible for any debts that the business runs up. Even though a partnership is a simple and flexible way for two or more people to own and run a profit-making business together, there are some disadvantages. The partners have no financial protection if the business runs into trouble (each partner is responsible for the debts of the partnership as a whole). Possible disagreements between partners can also lead to dissolution of the partnership. LPs must register with Companies House.
Tax responsibilities:
You must also register the partnership for VAT if you expect your business’s taxable turnover to be more than £83,000 a year.
The nominated partner must send a partnership Self Assessment tax return every year. There are no restrictions on the residence or nationality of the members of a limited partnership.
All the partners must:
- send a personal Self-Assessment tax return every year
- pay Income Tax on their share of the partnership’s profits
- pay National Insurance
LIMITED LIABILITY PARTNERSHIP (LLP)
A Limited Liability Partnership is a hybrid of a partnership and a limited company. Unlike an ordinary partnership, each partners’ liability is limited to the money they have invested in the company. At least two of the partners must be “designated members” which means they have also extra responsibilities. LLPs must register with Companies House and have to file annual returns unlike LPs.
Tax responsibilities:
Every year, the partnership must send a partnership Self-Assessment tax return to HM Revenue and Customs (HMRC).
All the partners must:
- send a personal Self-Assessment tax return every year
- pay Income Tax on their share of the partnership’s profits
- pay National Insurance
You must also register the partnership for VAT if you expect your business’s taxable turnover to be more than £83,000 a year.
LIMITED LIABILITY COMPANY
The main difference between the options above and a limited liability company is that the business is treated as a separate entity from its owners, meaning the company’s finances are separate from the personal finances of the owners and it guarantees more protection in case the company fails. Shareholders and directors of the company can be individuals or other companies. They are not liable for the debts of the company unless they have given personal guarantees. Before a company can start operating it must be registered with Companies House. Together with the registration it is necessary to nominate a director who must be at least 16 years old. There are no restrictions on the residence or nationality of the directors.
Tax responsibilities:
Every financial year, the company must:
- put together statutory accounts
- send Companies House a confirmation statement (previously annual return)
- send HMRC a Company Tax Return
The company must register for VAT if you expect its taxable turnover to be more than £83,000 a year.
If you’re a director of a limited company, you must:
- fill in a Self-Assessment tax return every year even if you are not a resident of the UK
- pay tax and National Insurance through the PAYE system if the company pays you a salary
There are three sub-types of limited liability companies:
Private limited companies
limited by shares or a guarantee, can have one or more shareholders. They cannot offer shares to the public. No share capital needs to be paid up.
Public limited companies
must have at least two shareholders and must have issued shares to the public to a value of at least £50,000 or the prescribed equivalent in euros before they can start trading. A quarter of them, £12,500, must be paid up.
Private unlimited companies
are hybrid companies incorporated either with or without a share capital but where the liability of the members or shareholders is not limited. An unlimited company may be formed with a single director and member, who may be the same individual. Commonly, this type of company is chosen where the owners do not wish the company’s accounts to appear on the public record. It is recommended you take legal advice before creating one.
Regulations when setting up a business in the UK
In case you decide to set up a business in the form of sole trader or partnership, as soon as you start trading you must inform HM Revenue and Customs (HMRC), the UK tax authority, which administers tax and National Insurance contributions across the UK. A sole trader or a partner will be classified as self-employed and thus you will need to make arrangements for self-assessment of income tax and for paying your own National Insurance.
For Limited Companies, The Companies Act 2006 requires the owners of the company to lodge a number of documents and information such as the memorandum, the name of the company, the names of the directors with the registrar at Companies House. It is also required to prepare, maintain and submit annual accounts and confirmation statements to Companies House every year.
Online applications for limited companies are usually registered within 1-2 working days and cost £12. Postal applications take 8 to 10 working days and cost £40.
