For most businesses there are 4 options for a bushiness structure, and they all have different advantages and disadvantages from a tax point of view and commercially. These are Sole Trader, Partnership, Limited Liability Partnership [LLP] or Limited Company.
So lets have a look at each option.
This is the simplest structure for a new business but not necessarily the most common. There is one person who runs the business as a self employed individual.
The profits earned are taxed through income tax and this soon becomes costly as profits in excess of around £40,000 per year are taxed at 40% and profits over £150,000 per year are taxed at 45%.
On top of this profits between around £10,000 per year and £40,000 per year attract national insurance at a rate of 9%. Profits over around £40,000 per year attract national insurance at a rate of 2%.
On top of this the self employed pay extra national insurance at a rate of around £3 per week.
Once arriving at profits the sole trader is taxed in a very similar way to the employed, the only concession to giving up holiday pay, sick pay and redundancy is a small reduction in national insurance.
Sole traders also pay tax on the profits that the business makes under tax rules and not the amounts that the business owners draws out for their own use. So if you’re leaving money in the business to invest in its future you still pay tax on that even if you don’t receive it personally.
The other thing to consider is risk. When you are self employed then you are personally responsible for all the debts of the business. This would include employees or customers suing the business.
This means all your personal assets are up for grabs if something went wrong including your home.
There is a bit less administration by opting for the sole trader route and the company car rules are a bit more favourable.
But overall unless you’re not intending to make too much money and the business is low risk then maybe the sole trade is not for you.
This structure is very similar to a sole trade but there are more than one of you running the same business. The tax rules for each partners’ share of the profits are the same as a sole trader and the partners are jointly and severally liable for the business’s debts.
This is sometimes used in a husband and wife situation because jointly the business can make around £85,000 profit before paying higher rates of tax.
In the last 10 years the Limited Company structure has been the most popular route for business start ups.
This has been due to more favourable tax and national insurance rates together with the Limited liability status.
Companies pay tax at 20% on profits and this is set to fall in the future. But with a Company the entity is completely separate from the individuals involved.
With a Company you have shareholders and these are the people that own the business. They appoint Directors to handle the day to day running of the business om their behalf. In most owner managed businesses the owners and the Directors are the same people.
In order the extract funds from the company the owners are paid dividends and these dividends are decided by the Directors. In addition the Directors can be paid salary for running the Company.
The shareholders pay tax on the Dividends received at a rate of 0% on the first £5,000 per year, 7.5% on roughly the next £35,000 per year, 32.5% on the next £110,000 and 38% on anything above that in a year. Each shareholder has this tax structure and its is only on amounts paid as dividends.
So this mean the shareholders only pay extra tax on the amounts that they draw from the business, unlike the self employed or partnership. The following illustrates this where a business makes £300,000 profit but leaves the profits in the business to invest.
|Corporation tax at 20%||60,000|
|£43,000 at 20%||8,600|
|£107,000 at 40%||42,800|
|£150,000 at 45%||67,500|
The other advantage to a Limited company is the limited liability status. This means that so long as the Directors run the business in line with the Companies Act and do not trade whilst insolvent then in the event of the company failure then the shareholders and Directors would not be personally liable.
Limited Liability Partnership [LLP]
An LLP is a combination of a Limited Company and a Partnership. It enjoys the Limited Liability status of a Limited Company but pays tax like a partnership. There are ways to also obtain the tax benefits of a Limited Company with an LLP with a special structure but you would need to discuss this with is in more detail.