Choosing a Business Structure
When starting a new business there are a multitude of decisions to be made. The best way to work through these is to use a good business plan template – see www.gov.uk/write-business-plan for examples.
One critical decision is determining the business structure – will you operate as a sole trader or set up as a company?
The outcome will depend on a number of factors unique to your circumstances including business size, growth forecasts, funding, tax implications and the industry you operate in.
The key differences between the two structures are outlined in the following table:
|Sole Trader||Limited Company|
|Liability||There is no distinction between the business and its owner. Liability is unlimited, meaning any business debt can be met from the owner’s personal wealth if the business fails.||Liability is limited to however much has been invested in the business and any personal guarantees.|
|Taxation of profits||Self-assessment regime||Corporation tax regime|
|Tax rates||After taking your personal allowance of £10,000 into account you will be paying 40% on profits as soon as they top £41,865 and 45% above £150,000.||The tax regime is more favourable, as corporation tax is currently set to a maximum of 21%. Company directors are taxed as employees and the level of salary paid and dividends extracted can be set to manage taxes due.|
|National Insurance||Class 2 NI is payable at £2.75 per week on profits over £5,885 Class 4 is due at 9% of profits between £7,956 and £41,865. Above that an extra 2% is due.||Companies pay ‘secondary’ Class 1 National Insurance contributions on their employees’ earnings. The rate is 13.8% on all earnings over £153 per week. The first £2000 is currently exempt under the Employment Allowance scheme.|
|Payment of taxes||If your tax bill is over £1,000 you will have to make payments on account – i.e. pay in advance. These instalment payments are made in January and July of each year.||Corporation tax is due 9 months after the end of the financial year. Instalments are not due unless profits exceed £1.5m.|
|Credibility||Suitable for micro businesses with small profits whose business partners are happy to transact with them.||Adds credibility to the business making it easier to borrow money.|
|Administration||This is the simplest business structure. The structure is inexpensive to set up because there are few legal and tax formalities.||Administration is more onerous: minimum requirements are annual statutory accounts and HMRC corporation tax submissions. An accountant is generally engaged to prepare annual accounts and corporation tax (at a minimum).|
|Income extraction||Profits can be extracted as and when needed. However, you need to ensure enough cash is set aside to manage the business and meet and tax payments due.||Company profits are mainly distributed in the form of salaries, dividends to shareholders or loans. Directors must declare income through the self-assessment system (i.e. dividends and salary payments)|
* The rates shown in the above table are for the 2014/15 tax year.
If you are a contractor, be aware of the IR35 regulations which relate to ‘disguised employment’. If HMRC deem your company falls into this category your business will be taxed as a sole trader and the limited company structure will be disregarded for tax purposes.
We can advise you on the best structure based on your unique circumstances and provide accountancy services as required.