LIMITED COMPANY vs SOLE TRADER - WHAT'S THE BEST LEGAL STATUS FOR YOUR BUSINESS?
"It's important to understand how best to structure your business, as your status can have both legal and practical implications"
One of the first considerations when setting up your business is to decide at an early stage how you intend to structure it. Setting up your business in the right way keeps costs down. It can also help prevent your working relationships turning sour, one of the major causes of business failure.
There are four main choices for the legal form of your business.
- Sole Trader: If you are a sole trader, you are self-employed, with no special legal structure.
- Partnership: In a partnership, two or more self-employed people work together as partners and share the profits (or losses).
- Limited Company: A limited company is a separate legal entity, distinct from its shareholders, directors and employees. Unlike a sole trader or partnership, it is not the same as the individuals who own or run it. For example, it is a separate legal entity and can sue or be sued in its own name. Visit the company formation wizard for further help and guidance.
- Limited Liability Partnership: this structure has some of the advantages (and disadvantages) of both a company and a partnership. For example, it is a separate legal entity and can continue despite the resignation or death of some members. Visit www.company-wizard.co.uk for further help and guidance.
Other legal forms can be used. For example a co-operative belongs to the employees.
Community Interest Companies give social enterprises the flexibility of the limited company form, but with additional features to ensure that they operate for the good of the community, not simply for private gain.
1. SOLE TRADERMost small start-up businesses find that setting up as a sole trader is the best option. A sole trader is when a person is in business on his or her own account. As a sole trader you will be self-employed and solely liable for any debts the business acquires.
- Income tax must be paid on any profits your business makes.
- A self-assessment tax return must be completed each year, detailing both your business income and expenses.
- Detailed records must also be kept of all your income and expenses.
- As self-employed you must register with HM Revenue and Customs (HMRC), £100 penalty is levied if you fail to register within the first 3 months of trading.
- VAT registration is mandatory if your turnover is going to be more than £70,000 a year. This means you'll charge VAT on all your good or services, and will have to complete and submit a VAT return to HMRC each year.
- Profits you make will be taxed (as this will be your income) in the form of National Insurance Contributions (NICs), either Class 2 or Class 4. The HMRC website has details of current rates.
- You will also have to satisfy HMRC that you genuinely are self-employed. The chief test is that you work for a range of clients and charge for work done on a case-by-case basis. If you were on a retainer for a single customer, HMRC could well conclude that you are an employee in everything but name and insist that you are taxed at source by your client through the PAYE system.
- One of the easiest ways to set up a business is as a sole trader.
- You can set expenses against your overall income.
- You are your own boss.
- There is no separation between your finances and those of the business. If the business makes a loss and/or you incur large debts, then you alone are liable.
- No matter how successful you are as a sole trader your business.
2. PARTNERSHIPA partnership is a business structure whereby 2 or more people (up to a maximum of 20) are self-employed and in business jointly to make a profit. All individual (partners) share the business profits, costs and debts - irrespective of who incurred the debt or made the profit. Partnerships work well when each partner has different skills base or areas of expertise to bring to the business and the workload is divided up to reflect each of the partners' strengths.
It is important to highlight that partnerships have no legal status as companies in their own right. As is the case with sole traders, the finances of the business remain indivisibly tied to the finances of the individuals who form the partnership, therefore if the venture fails, it is the partners (not the business) who are responsible for paying any outstanding debts.
- Each Individual in the partnership and also the partnership itself needs to complete a self-assessment tax return each year, detailing their income and expenses. They also have to keep records of all your income and expenses.
- As a partner, you must register with HM Revenue and Customs (HMRC), £100 penalty is levied if you fail to register within the first 3 months of trading.
- VAT registration is mandatory if the partnership's turnover is going to be more than £70,000 a year. This means you'll charge VAT on all your good or services, and will have to complete and submit a VAT return to HMRC each year.
- Each Individual in the partnership is taxed on their share of the profits in the form of National Insurance Contributions (NICs), either Class 2 or Class 4. The HMRC website has details of current rates.
- A Partnership is a simple structure to set up.
- There is no requirement to file accounts or register with Companies House.
- Unlike limited companies, there is no corporation tax to pay.
- The partners are liable for all debts.
- Partnerships can be difficult to sell, as the business itself has no legal status.
- The law assumes all partners have an equal share in the business. This may not be the case; therefore, a watertight legal agreement is required, setting out the exact terms of the partnership.
3. ESTABLISHING A LIMITED COMPANYAll limited companies must be registered as incorporated at Companies House. The easiest way to do this is to find a company formation specialist who will handle the legal paperwork and run a search to ensure that your proposed company name is not already in use by a similar business. The Company Formation Wizard is a simple, cost-effective way to register your limited company in the UK.
A limited company is where the shareholders (owners or members) have limited liability to the company's debts. Their liability is restricted to the value of the shares that they own or the personal guarantees they enter into, for example a business loan they have provided a personal guarantee for surety.
A limited company is a separate legal entity in its own right. The company can sue and also be sued, it will also continue to exist even if the owners or members resign or die. It can only be folded if it is voluntary/involuntary wound up or struck off the Companies register by Companies House, usually for non filing.
In return for these benefits, limited companies are governed by tighter rules and regulations than partnerships or sole traders.
- The accounts must be filed each year and registration with Companies House is required. Visit www.company-wizard.co.uk for further help and guidance.
- The Company is required to pay corporation tax and each year to file a return with HM Revenue and Customs.
- Employees and directors have to pay income tax as well as Class 1 National Insurance Contributions (NICs).
- Each year an annual return will need to be completed by the company (before the anniversary of incorporation). This annual return must be checked with any changes made before filing with Companies House along with the required monies.
- Companies House must be notified of any changes to the management or structure of the company, this can be done online.
- Most companies start life as private limited companies. However, many go on to become Public Limited Companies (PLCs) and as such their shares can be traded on the stock market.
- A limited company can raise money by selling shares.
- Shares in limited companies can be sold when shareholders want to cash in.
- A limited company provides a good platform from which to grow a business.
- There can be tax advantages to incorporating rather than remaining as a sole trader.
- Director responsibilities can become a burden.
- Filing annual accounts and tax returns can be a complex business.
4. LIMITED LIABILITY PARTNERSHIP (LLP) All LLPs must be registered at Companies House and file corporate accounts every year, a legal agreement should exist that defines the terms of the partnership. The easiest way to do this is to find a company formation specialist who will handle the legal paperwork. The Company Wizard is a simple, cost-effective way to register your LLP in the UK.
This legal business structure aims to combine the benefits of limited liability with the flexibility of a partnership arrangement. The principal differences between an LLP and Limited Company are that the LLP is taxed as a partnership rather than as a corporation.
- File annual accounts and returns at Companies House, facing penalties if they are late.
- Each year an annual return will need to be completed by the LLP (before the anniversary of incorporation). This annual return must be checked with any changes made before filing with Companies House along with the required monies.
- Individual partners and the partnership need to complete a self-assessment tax return each year, detailing income and expenses. You also have to keep records of all your income and expenses.
- Have at least 2 'designated members' - these members have more responsibilities than other company members and they will be held accountable for failing to fulfil them.
- Notify any changes to members, officers or registered office address.
- Partnership members get taxed based on the share of the profits they receive. They also pay National Insurance Contributions.
- Partnerships are flexible structures. New partners can be taken on as the business grows, and they offer protection to members if the business fails.
- Partnerships must keep and file detailed accounts, making them much more saleable than sole trader businesses should one or more partners decide to cash in.
- Partnerships are not subject to corporation tax.
- The paperwork can be time-consuming. Filing accounts, for example, can become increasingly complex as partnerships grow.
TAKING ON EMPLOYEESIf you decide to employee staff then you will need to put a payroll system (PAYE) system in place, you need to deduct and collect income tax and NICs from any employees, this will then need to paid to HM Revenue and Customs regularly on time.