We’re currently helping a number of clients regarding setting up their own business. It’s important to get it right and there are a number of aspects to consider.
When a business starts up there are a number of different structures under which it can operate. Each has its own implications and their suitability depends on a number of factors. There isn’t a universal answer to what is the best form of legal or tax structure to use and there are advantages and disadvantages with each option. As always with a decision as important as this for your business, you should take professional advice from a qualified accountant before making a commitment.
The two most common trading vehicles are discussed below:
A sole trader is a type of business entity that legally has no separate existence from its owner. The law makes no distinction between the business and the sole trader – they are one and the same.
If you start to trade as a sole trader, you should inform HM Revenue & Customs (HMRC) straight away and register for self assessment. The very latest you can register is by 5 October after the end of the tax year for which you need to file a tax return.
- As a sole trader you will only need to prepare basic accounts and a self assessment tax return. Consequently the accountancy fees tend to be lower for a sole trader as there is reduced administrative burden.
- Many businesses are initially loss making. If you leave a job to become self-employed, and make a loss, you can offset that loss against your previous employment income. If you have other income such as savings interest, dividends, or rental income, then again, the sole trader losses can be set-off against these. This can result in a repayment of tax in the early period of trading. With a limited company, losses cannot be offset against your personal income.
- As a sole trader, you only need to submit information to HMRC. Your sales income, profits and tax affairs are private between you, your accountant and HMRC. Limited companies must file accounts with Companies House which are in the public domain for anyone to see, although the amount of financial information available is usually limited.
- Because there is no legal separation between the individual and the business, a sole trader is liable for all the business debts and this can put at risk not only assets used in the business but also personal assets too.
- A sole trader business usually ceases on the owner’s retirement or death.
- Options for raising finance are more restricted for a sole trader.
Sole traders and partners can be held personally liable for all business debts but a limited company is a legal entity separate to its directors and shareholders. As a separate corporate body, a company can own property, incur debts, sue and be sued in its own right. Any business dealings are made on behalf of the company so the owners are normally liable only for the amount invested as shareholders. There must be at least one director to manage the business.
- Limited liability status provides some protection for you as a director if the business is not successful. In simple terms if a company cannot afford to pay all its debts the directors will not normally be personally liable for them.
- Shares in a company can be created and transferred to divide the ownership subject to company law and the company’s constitution contained in a document called the Articles of Association. Careful consideration must always be given to the tax consequences of any share transfers.
- A company as a separate legal entity survives the retirement or death of its owners.
- A limited company can be perceived as having more credibility making it easier to raise finance. Financing options such as debentures and invoice discounting are available to companies which are not available to sole traders.
- A company can pay dividends to shareholders which can be advantageous in reducing the overall tax payable compared with income paid as salary which is subject to tax and both employee’s and employers National Insurance (NI).
- Limited companies are taxed on their profits at corporation tax rates (typically lower than personal income tax rates) and can offer tax advantages.
- Some business customers may feel more comfortable trading with a limited company rather than a sole trader. They may have a perception that a limited company will be a more established business, and therefore more reliable. The reality of course that creditability is more to do with how you market and present your business and ultimately how effective you are at meeting the needs of your customers.
- Annual accounts are more complicated to prepare and specific details and disclosures need to be filed with the Registrar of Companies. This usually makes it necessary to use a qualified accountant to prepare accounts for the company.
- Information about the business will be in the public domain for anyone who is interested to see.
- Directors are treated as employees for any salary that they draw and so are subject to income tax and NI on their salary from the company. In addition, the company must also pay employer’s NI on the directors’ salaries.
- Shareholders and directors may have to personally guarantee contracts entered into with lenders or suppliers so personal liability can still arise.
- It can be more difficult and expensive to close or wind-up a company compared to a sole trader or partnership business.
- A company director is more at risk of civil or criminal proceedings or penalties which can arise for late filing of accounts or from breaches of insolvency rules such as those relating to wrongful of fraudulent trading.
Other things to consider:
- Depending on your trade or sector, you may need some form of statutory licence to run your business.
- You must have adequate insurance for the business. If you have employees, you must have employers’ liability insurance.
- Notify HMRC when you begin trading and use an accountant to help you keep your tax, NI and VAT affairs in order.
- You must ensure your premises comply with regulations. If your business is based at home, you need to consider whether your title deeds, mortgage or tenancy agreement places any restrictions on this.
- If part of your home is treated as non-residential there may be tax implications.
If you would like more information regarding setting up your own business, please get in touch, we’ll be delighted to hear from you.