There are different legal and taxation treatments applicable to each, but your main options are:
• Sole trader
• Limited liability partnership (LLP)
• Limited company
Under a sole trader arrangement, you and your business are considered one and the same – from both a legal and a tax perspective. You are personally responsible for the business and all its activities and any debts it owes. The profits the business makes (sales minus costs), to 5 April each year, are declared on your annual self-assessment tax return and classed as your personal income in that year, even if it is not paid out as salary, or into to your personal bank account. You must pay income tax and national insurance on this at the standard income tax rates. You do not need to register the business as such but you should tell HMRC that you are operating a business and need to be taxed under self-assessment.
A partnership is similar to a sole trader arrangement, but with more than one owner. All partners own a specified percentage of the profits (and the liabilities) and paying tax on that percentage of them. Again, each partner’s share of the profits is treated as their income.
An LLP is basically a partnership that also has some characteristics of a limited company. LLPs tend to be used for professional services firms, such as solicitors, accountants and architects.
If you choose to form a limited company to carry out your business, the business becomes a separate legal entity in itself. The company must be formed, or incorporated, and registered at Companies House and it will have certain standard legal documents that govern what it can do and what business it operates in.
The company will be owned and controlled by those who own its shares, in proportion to the number and value of shares owned, and you can allocate shares to any number of people when the company is incorporated. You could retain all of the shares for yourself, allocate some to a spouse, or sell the shares (‘equity’) to raise funds.
You would also be a director of the company and you can appoint other directors. These are essentially the senior employees of the company and it is the directors’ responsibility to run the company in line with all applicable laws and regulations.
BENEFITS OF LIMITED COMPANIES
While it is true that a limited company does require more administration – for example annual accounts being filed at Companies House and an annual corporation tax return – these can be taken care of quickly and smoothly by an accountant. There are also significant benefits to having a limited company, including:
• They tend to be much more tax efficient, due to the ability to receive income in the form of both salary and dividends, where dividends attract a lower tax rate and no national insurance
• They separate the liabilities (debts) of the business from that of the owner(s), reducing the risk if things go wrong
• They tend to convey a more professional image of the business, as far as the perception of customers and suppliers is concerned
• They are easier and more flexible when it comes to raising investment and funding – since equity can be sold
Whatever route you decide to take – whether you’re a one-man-band, or a group of like-minded go-getters driving your small start-up – you will benefit in the long-term by setting out on the right track with the structure in place to set the groundwork.