What structure should I use for trading?
One of the very first things you need to consider when you’re setting up a new business, is which business structure you’re going to choose. You’re probably here because you know a few of the different options – sole trader, limited company… but you’re unsure of the factors that need to be considered in order to make the best decision.
Alternatively, you may have arrived at this article because the existing business structure you’ve chosen is causing you to pay more tax than is necessary. Are you drawing your income in the most tax efficient way?
Everyone’s circumstances are different so there isn’t a ‘one size fits all’ method by which you can keep your tax bills to a minimum. However, it is useful to know the options available to you.
Sole trader or limited company? Partnership or LLP?
Let’s get into the nitty gritty…
Choosing to set up as a Sole Trader
Setting up as a Sole Trader is one of the most popular options for those starting out as a one-man-band, often chosen by financial traders. If you’re not starting out with a big chunk of cash, or looking to raise serious capital, this is the simplest structure to choose.
When you set up as a Sole Trader, the law makes no distinction between the business and its owner. Liability is unlimited, meaning that any debt can be met from the owner’s personal assets if the business fails. Your profits are taxed as income by HMRC, and as you are self-employed, your tax will be self-assessed.
It’s when the business starts to grow that problems emerge, and we see the cons of setting up as a Sole Trader. Since your profits are taxed as income, you will be paying 40% as soon as they top £41,865 and 45% above £150,000. This is the case even if those profits are tied up in trading account balances and assets. You could be paying higher rate tax even if you have no money to live on!
Choosing to form a partnership
A Partnership is a similar set up to that of a Sole Trader, apart from the fact that it involves more than one individual. This is a popular option for married couples and individuals who already know each other well and are wishing to join together to share trading strategies or funds.
Again, as with the Sole Trader structure, profit will be taxed as income, meaning each partner will also have to register as self-employed. We see that disadvantage again, of paying more tax when you meet the higher threshold.
Choosing to incorporate a limited company
Deciding to incorporate a Limited Company means becoming the managing director of a registered company where your personal money is separate from the business’ money.
The biggest advantage to this structure, is that you’re protecting yourself against financial risk. If the business fails, your personal assets are protected – it is only the business (and anything you’ve put into it) that will bear the brunt of the financial liability.
Incorporating as a Limited Company is also a favoured option in terms of tax. As a Limited company, you’ll pay corporation tax, instead of income tax, and as a Director, will be taxed as an employee in the same way as anyone else who works for the company. Although there is extra tax to pay on dividends, most business owners find that overall they pay less tax when trading through a limited company.
With director status, however, comes greater responsibility. You will be required to submit full statutory accounts and a company tax return to HMRC each year, as well as making monthly or quarterly payments of employee’s income tax and NICs. You will also have to file statutory accounts and an annual return to Companies House. And there are a number of legal responsibilities you have to fulfil in the way you work on a day to day basis especially if you suspect that the company has become insolvent.
Choosing to incorporate a limited liability partnership
A Limited Liability Partnership (LLP) is a combination of elements from a limited company and from a partnership. It is taxed like a traditional partnership but has the protected liability of a company.
Like limited companies, the LLP structure protects its members’ assets, limiting their liability to only what they have invested in the business. But it doesn’t have the same tax advantages – income is still personal income, and will be taxed as so. A disadvantage of the LLP is also the requirement to submit accounts to Companies House for the public record.
But like a traditional partnership, there is the flexibility! Decisions made about how the business runs, and about distribution of profits is determined by a written agreement.
Starting a business is exciting, scary and (let’s be honest) very confusing, and this is just a short explanation of the four most popular options for trading.
Are you struggling to choose the right structure? Or fear you may have chosen the wrong one initially? Our experts can help assess your individual situation and discuss in detail which would be best fit. Email email@example.com or call 01474 853 856 for support and specialist advice.
Please note that figures stated within this article presume that the only form of income is that from the trading activities and personal circumstances may differ from the examples shown.
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