So you’re about to set up your own business – congratulations! Now that you have a business idea and a plan for how to bring it to market, the next step is choosing the right business structure for yourself.
In the UK, you have four options – sole proprietorship, partnership, limited company, and Limited Liability Partnership (LLP).
Each of these has its own paperwork requirements and tax implications, and choosing one comes down to your priorities and bandwidth as a business owner (and what your accountant recommends is best for your specific venture).
In this blog post, we’ll talk about each of the four main tax structures for a business, and outline the pros and cons in detail to help you decide which one to pick.
1. Sole proprietorship
This is the most common business structure in the UK, and the easiest to set up. Approximately 56% of the businesses operating in the UK today are sole proprietorships. In this structure, you take all the decisions and keep all the profits from the business.
Setting one up requires minimal paperwork and the least costs among all four structures, which is largely why it’s so popular. It also involves the least amount of day-to-day paperwork to maintain. Typically, you’ll manage taxes via Self Assessment, for which you can register through HMRC’s online portal.
Tax implications:
- As a sole trader, you are required to pay income tax on any profits above your personal allowance, which is £12,570.
- Depending on how much you earn, your tax rate will range from 20% to 45%.
- If your turnover crosses £90,000 per year, you’ll need to register for VAT. (You can also voluntarily register if your turnover is below that.)
- You also have to pay Class 4 National Insurance. Since April 2024, Class 2 NIC no longer has to be paid though it is worth considering payment on a voluntary basis to protect your eligibility for certain benefits.
The downside is that you are personally responsible for all debts you incur as a sole trader. So if your business is sued or goes bankrupt, you need to pay the dues out of your own pocket.
2. Partnership
This involves going into business collectively with one or more partners, either people or “legal persons”, i.e. limited companies. Each partner shares responsibility for the business liabilities and profits in an agreed-upon ratio, and will have to help with bills, expenses, and debts out of their pockets.
Setting up a partnership involves:
- Choosing a business name that is original, not offensive, and does not contain any variation on “limited”
- Appointing a nominated partner to maintain records and handle business tax returns
- Registering online for Self Assessment
There is some paperwork involved in the process, but much less than for Limited Liability Partnerships or limited companies. You also have the benefit of being able to rely on your partners for business advice and of sharing any liabilities with them.
Tax implications:
- Each partner needs to register with HMRC as self-employed and do their own annual tax returns.
- Tax rates are the same as in a sole proprietorship. The rules about VAT registration also apply.
- Each partner is legally entitled to their share of the profits and legally responsible for their share of any losses.
The downside of a partnership is that it’s much more vulnerable to interpersonal conflict. If the partners can’t agree on how to manage the business, it could potentially bring the whole partnership down. There’s also much less individual autonomy than as a sole trader.
3. Limited company
A limited company is designed to be its own entity, i.e. it separates itself from the people who run it. So when you set up a limited company, you are not personally required to cover legal costs or company debts. Limited companies are either “limited by share” or “limited by guarantee”.
Setting up a limited company involves:
- Choosing an original, inoffensive name
- Choosing directors who will be responsible for maintaining business records, filing accounts, and reporting any company changes
- Choosing shareholders or guarantors who will be responsible for the company’s financial liabilities (to the extent of the share amount they have paid or the debt guarantee they have agreed to)
- Choosing at least one shareholder or guarantor who can serve as company director
Identifying people with significant control (PSCs), including those holding more than 25% of the company’s shares - Preparing documents that record how the company will be run
- Registering the company with a Standard Industrial Classification (SIC) code and an official company address
Tax implications:
Rather than pay income tax or direct National Insurance, limited companies need to pay Corporation Tax, which is typically 15% to 25% of their net profits.
You will have to register for VAT if the company earns over £90000 per year.
There are several tax benefits a limited company can be eligible for. Ask your accountant about these.
If your limited company employs staff (including yourself as a director), it must pay Employers’ National Insurance Contributions.
On the downside, running a limited company involves a lot of paperwork and strict rules around how you maintain company accounts.
You have to maintain complete records of all your financial transactions and send annual statements to Companies House, for which in most cases you’ll have to hire (and pay for) a specialised company accountant.
And if you fail to follow the rules, you could attract hefty fines from HMRC or even lose your position as company director.
4. Limited Liability Partnership
This tax structure combines the features of a partnership and a limited company. Like a partnership, each individual or legal entity who serves as partner is entitled to a share of the profits.
And like a limited company, each partner is only liable up to the amount they have invested. Which means, as a partner in a Limited Liability Partnership, your personal finances are kept separate.
Setting up a Limited Liability Partnership involves:
- Choosing an original, inoffensive name
- Registering an official address
- Registering the LLP via post, third party software, or a formation agent
- Making an LLP agreement on how the business will be run, signed by each partner
- Choosing at least two designated partners to handle accounts and take on other core responsibilities
Tax implications:
The Limited Liability
Partnership is not a separate legal entity, so the partners distribute profits and pay taxes via Self Assessment.
You will have to register for VAT if the partnership earns over £90000 per year.
You have to report any LLP changes to HMRC and Companies House.
You are required to distribute profits to members during the same year that they are realised.
The downside is that there’s a lot of paperwork and administrative burden involved, just like with a limited company.
Final words
So which tax structure is right for your new business? The answer, ultimately, boils down to how much administrative responsibility you’re willing to take on and what financial consequences there will be.
Remember – while structures like sole proprietorship might be easier to set up and handle, you also get more tax benefits and protection from liability when you run a more complex structure like a limited company.
As always, we recommend working closely with your accountant to choose the most tax-efficient structure and be prepared for whatever paperwork that might entail. Need some expert advice? Reach out to the Lyel Accountants team today to get started.
