Key words: Limited Company, Sole Trader, Partnership, Business, Benefits, UK, International, Individuals, Advantages.

ABSTRACT

In this article, the different types of businesses will be discussed as well as the benefits of having one of the three popular business types in the UK.

INTRODUCTION

There are three common ways of doing business in the UK, these are known as sole trader, partnership, and limited company. Setting up a business depends on the type of work that is delivered because this will also affect how you pay tax and receive funding. All business types will be discussed in this article.

SOLE TRADER

Sole Traders1 are responsible for running their business as an individual as well as being self-employed. Therefore, this means keeping track of all business profits and losses. All business profits can be kept if tax is paid on them.

Some responsibilities for being a sole trader includes, keeping records of the business's sales and expenses, complete a self-assessment tax return every year. Income tax2 would need to be paid on profits earned along with Class 2 and Class 4 National Insurance tax. Sole traders pay tax at 20%, 40% or 45%, and NIC Class 4 is 9% and 2% depending on their level of taxable income. International individuals will need to obtain a national insurance number to set up a business in the UK.

If the company is within a construction industry and working as a subcontractor or contractor, the sole trader would need to register with Her Majesty's Revenue and Custom (HMRC) for the Construction Industry Scheme (CIS).

The advantages and disadvantages of being a Sole Trader are as follows;3

  • Advantages are:
  • Immediate effect;
  • No registration for companies' house is necessary;
  • Complete control over finances (no other partners to share profit with);
  • Less paperwork;
  • Fewer responsibilities on Tax;
  • Flexibility.

Disadvantages are:

  • Unlimited liability (personal assets could be at risk if any outstanding debt);
  • Responsibility over the business (having finances and the job itself to work around).
  • Sole Traders with a taxable turnover of £85,000 per year would need to be registered for VAT4. This is for the purpose of reclaiming the VAT if goods are sold to another VAT registered business.

PARTNERSHIP

A partnership is a formal agreement by two or more people, to manage and operate a business and share its profits. There must be partnership agreement in place, and this consist of each partners capital contributions, duties as partners, sharing and assignment of profits and losses, acceptance of certain liabilities and dispute resolution.

Partners will share the business's profits and each partner's tax amount will depend on their share of profit. All partners pay income tax at 20%, 40% or 45%, and NIC Class 2 and Class 4 is 9% and 2% depending on each partners share of profit and level of taxable income.

Registering the partnership for Self-Assessment with Her Majesty's Revenue and Customs (HMRC) is mandatory. This would have to be done by the 'nominated partner' who is willing to be responsible for sending the partnership tax returns. Other partners in the business will need to register separately for their own self-assessment tax returns. Penalty could be charged if not registered by 5 October in the business's second tax year.

The advantages and disadvantages of being in a partnership business are as following5.

Advantages are:

  • Simple to get started;
  • Having different experiences, skills, and knowledge to share with partners;
  • Decision making is easier with partners;
  • More partners, means more capital.

Disadvantages are:

  • Unlimited liability;
  • Differences and conflicts between partners;
  • Decision making can also be difficult with partners;
  • Profit sharing with other partners
  • Companies with a taxable turnover of £85,000 a year would need to be registered for VAT. This is for the purpose of reclaiming the VAT if goods are sold to another VAT registered business.

LIMITED COMPANY

Limited companies differ from partnerships or sole trader businesses. When looking into a Limited Company business Limited by shares and Limited by guarantee must be considered.

Limited companies, being limited by shares, are legally separate from the people who run the business, it is designed for businesses that make a profit. It has separate finances from personal finances, also profits can be kept after tax is paid on it as well as having shares and shareholders.

On the other hand, Limited companies, being limited by guarantees do not seek for profit but aim to re-invest the profit back to the business.

In order to create a Limited Company, there are a number of points to follow, these are6;

  • Checking if a Limited Company is the right business to set up with the following points;
  • Choosing a name for the business;
  • Must appoint a company director and a company secretary (not always necessary);
  • Deciding on whether to go for Limited by Shares or Limited by Guarantee
  • Identify people with significant control over the company (anyone with voting rights or more than 25% of the shares);
  • Prepare a memorandum of association and articles of association;
  • Check what documents that need to be kept;
  • Register the company for a Standard Industrial Classification (SIC) code7, this identifies what type of business the company does.

Keeping accounting records are mandatory for a limited company, failure to do so will result in a £3,000 fine by HMRC or be disqualified as a company director. Consequences of being disqualified as a company director is conviction; imprisonment for up to two years or a fine, or both depending on the level of criminal activity carried out. The disqualified director will not be able to act as a director or manager within this period, this can be up to 15 years.

Yearly accounts must be published onto Companies House. Consequences for not doing so are fines, according to the time passed after the deadline. Penalties for up to 1 month is £150, 1 to 3 months is £375, 3-6 months is £750, and more than 6 months is £1,500.

The records that need to be kept include, all money received and spent by the Limited Company which includes all grants and payments received from coronavirus support schemes, details of assets owned by the Limited Company as well as debts the company owes or is owed and the stock the company owns at the end of the financial year.

Records of the money spent by the Limited Company, i.e., receipts, petty cash books, orders, and delivery notes as well as invoices, contracts, sales books, bank statements and other correspondence will need to be kept as information is used for annual accounts and company tax returns. All records need to be kept for minimum six years.

There are more benefits on setting up a Limited Company rather than the other two businesses mentioned8.

Advantages are:

  • Limited Companies are more tax efficient with also dividend advantage as they are taxed at a lower rate;
  • 19% corporation tax on profits (from 2023 it will be 25%) as opposed to the 20%-45% income tax that Sole Traders have to pay on their profits;
  • Limited liability where the company directors or shareholders are responsible for the debts of their business;
  • Professional status with Companies' House
  • Company pension schemes, contributing to a pension can bring significant tax advantages as it is treated as an allowable business expense;

Disadvantages are:

  • Unlike a Sole Trader, Limited Companies are more complicated to set-up
  • A cost to set up the company
  • Monthly records need to be kept for filing accounts
  • Accountancy and professional fees (these are necessary to avoid penalties from Her Majesty's Revenue and Customs and Companies House);
  • More paperwork and legal requirements

Companies with a taxable turnover of £85,000 a year would need to be registered for VAT9. This is for the purpose of reclaiming the VAT if goods are sold to another VAT registered business.

CONCLUSION

Individuals can choose their business structures according to the nature of their business or circumstances. The three popular business structures are as mentioned above. However, Limited Company businesses are more in demand as there are more advantages that individuals can take advantage of.

Footnotes

1. https://www.gov.uk/set-up-sole-trader

2. https://startups.co.uk/tax/self-employed-sole-trader-tax/

3. https://www.bbc.co.uk/bitesize/guides/zpx7gdm/revision/3

4. https://www.gov.uk/vat-registration?step-by-step-nav=01ff8dbd-886a-4dbb-872c-d2092b31b2cf

5. https://www.bbc.co.uk/bitesize/guides/zpx7gdm/revision/4

6. https://www.gov.uk/limited-company-formation/memorandum-and-articles-of-association?step-by-step-nav=37e4c035-b25c-4289-b85c-c6d36d11a763

7. https://www.gov.uk/running-a-limited-company/company-and-accounting-records?step-by-step-nav=37e4c035-b25c-4289-b85c-c6d36d11a763

8. https://www.rapidformations.co.uk/blog/limited-company-advantages/

9. https://www.gov.uk/vat-registration?step-by-step-nav=01ff8dbd-886a-4dbb-872c-d2092b31b2cf

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.