When you set up a new business you need to think about how you’re going to structure it, because this will affect its legal status, how much tax it pays and when. This applies no matter how small your business is.
Here's how they each work.
This is the simplest kind of business structure. It’s just you, your computer and your dog - there’s nobody else involved in running the business.
You need to register with HMRC as a sole trader and this can be done by filling in a simple online form. You have to do this by 5th October after the end of the tax year (which runs from 6th April to 5th April the following year).
Once you’ve registered, you have to file a tax return every year, and if you file it online then you have until the following 31st January to do this. But you don’t have to file accounts anywhere - so, because your tax return is not on the public record, your business’s figures are kept private.
There’s no legal difference between a sole trader and his or her business. As a sole trader, you are the business as far as the law is concerned. So that means that if the business is sued, you are personally sued, and your own assets – for example, your home and your car – could be taken to pay the debts.
A partnership is just like a sole trader except that there is more than one person running the business.
This does mean that there’s no legal difference between the partners and the business, so if the business is sued, or one partner vanishes with the partnership’s money or other assets, the other partner or partners could lose their personal assets to pay the business’s debts.
To set up a partnership, you will need to register the business with HMRC. One partner would be the nominated partner responsible for filing tax returns to HMRC, and that person must register the partnership. The other partner(s) must also register. The deadlines for registering and for filing tax returns are the same as for sole traders, but not only must the partnership file a tax return, each partner must also file one - so there will be at least three tax returns to file each year.
Make sure that you draw up a partnership agreement covering important issues like what happens if a partner leaves the business or dies, how much money each partner will put into the business and how much he/she can take out.
Limited Liability Partnership (LLP)
The “limited liability” part of this structure’s name comes from the fact that it’s a separate legal entity from the partners, with a legal identity in its own right. This protects the partners’ own assets if the business is sued, unless they have been guilty of wrongdoing or given personal guarantees.
What’s the catch? Loss of privacy. An LLP must file accounts every year with Companies House, and a document called an annual return which lists the partners (or “members” for an LLP). These documents are on the public record, so anyone can buy a copy of them for a couple of pounds.
For tax an LLP is treated the same as a partnership, so it must be registered with HMRC and each partner must register, and then there are tax returns to file each year.
Running your business through a limited company can often result in a smaller tax and National Insurance bill than for the same business as a sole trader or partnership, which makes it a very popular business structure.
The company is a separate legal entity from the people who run it (its directors) and those who own it (its shareholders). For small companies, the directors will often own all the shares, but even if there is only one director who owns all the shares, the company remains a separate legal entity from that person.
This means that it has the same protection of limited liability for the owners’ assets as an LLP but - like an LLP - the quid pro quo is having to file accounts and an annual return at Companies House each year.
Company directors are also subject to legal obligations, for example they must not let the company keep trading if it can’t pay its debts, and they must look after the business’s machinery and other assets.
And, if a company’s costs outweigh its income in its early years, it’s not possible to put those losses against the directors’ other income and claim tax back. The company will only be able to reduce its tax bill by means of the losses once it starts making a profit. For all the other business structures, losses in early years can often be used to claim a tax refund against the owners’ other income.
It’s important to weigh up the advantages and disadvantages of each business structure and decide which best suits your business and your circumstances.
Disclaimer: The content included in this blog post is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this blog post. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.