Business Structure Types
When you start up in business you must choose which trading structure or ‘vehicle’ through which to operate. There are three types of structure which are most commonly used in the UK.
- Trading as a sole trader
- Trading with others in a partnership
- Incorporating a limited company
Which business structure is best for me? When you start trading, one of these structures may be the best choice. However, this can change over time as the business grows or your personal circumstances change. Your trading structure dictates how you are taxed and the extent of your liability for the business’s debts.
Trading as a sole trader
A sole trader consists of one self-employed person, running a business on their own. The business and its owner form one legal entity. This is a very flexible and popular way to trade. There are more sole traders than any other business vehicle in the UK.
You are only required to report your figures to the tax office. In all other respects, your business results are entirely confidential. However, sole traders are personally liable for any and all business liabilities, including tax arising from business profits. This means that personal assets are at risk if the business fails to make a profit.
All profits from the business are taxed in the year that they are earned. They are treated as the personal income of the sole trader. As a sole trader, you cannot charge your business for your time. Nor can you claim any deduction for use of your own land or property in the business.
The business can take on employees. However, the business owner is personally liable for reporting wages under RTI (Real Time Reporting). They must also ensure that all PAYE and National Insurance is paid to H M Revenue and Customs.
Trading as a partnership
A partnership is defined in law as two or more persons carrying on in business with a view to profit. A person may be an individual or any other entity such as another partnership, a limited company, or trustees. There are different forms of partnership and they are governed by different partnership acts.
There are four different types of partnership. However, the most commonly used in England and Wales are the General (or Conventional) Partnership and the Limited Liability Partnership.
The general partnership, also known as conventional partnership, is governed by the 1890 Partnership Act. There are many similarities between this and the trade of a sole trader. For example, the business and its owners are considered as one legal entity. It is worth noting that when it comes to the treatment of profits and taxes, the partners are responsible for one another’s debts. Like sole traders, the partners are taxed on all the profits that they have earned in the tax year. Although their share of the profits may vary by agreement. The partners are ‘jointly and severally liable’ for the partnership debts, including payment of taxes.
As with sole traders, the business owners are responsible for accounting, reporting and paying for all taxes of the business. However, the partnerships results are entirely private and not available to the public.
There are, however, some significant differences from a sole trader’s business. One of which is that individual partners may charge the partnership rent on property that is used for the business. Also, if the partnership makes a loss, those partners who are not fully participating in the business may be restricted from claiming sideways loss relief (offsetting losses against other income).
Limited Liability Partnerships
Limited Liability Partnerships (LLP’s) are governed by the 2000 Limited Liability Partnership Act and the 2006 Companies Act. Legally it is a cross between a conventional partnership and a company. Many consider that it has the best features of each. The business is a separate legal entity to its members (the partners), and generally speaking the partners liability is limited.
The profits of an LLP are taxed on the members as if it were a conventional partnership. And tax losses are restricted in proportion to each partner’s capital contribution.
Designated partners of the LLP are the equivalent to company officers. Certain members details and annual accounts are required to be filed with Companies House. Those records are then available to the general public.
LLPs are subject to substantial tax anti-avoidance legislation. The partners may lose their limited liability if the LLP becomes insolvent and the partners knowingly allowed this to happen. In which case, they may be required to repay their profits from the previous two years.
There are two main forms of company, Private and Public:
- Private companies can be unlimited or limited by shares or guarantee. For the purposes of trade, a company is usually limited by shares. Unlimited companies and companies which are limited by guarantee tend to be used for activities that have little or no commercial risk. These tend to be run as non-profit making or charitable companies.
- Public companies, or PLC’s, are set up in a similar way to limited companies. However, it is permitted to apply for listing on a recognised stock exchange and to offer its shares to the public in order to raise finance. It must have a minimum issued share capital of £50,000, of which 25% must be paid up.
Private Limited Companies
Private limited companies are governed by the 2006 Companies Act and are separate legal entities to its owners and directors.
There is often confusion between owners and directors. For many small companies these are often the same people. The distinction is that the company issues share capital, which is owned by the shareholders (the owners). They are entitled to vote on certain issues and are entitled to dividends. Directors are the officers of the company, responsible for running and managing the company to the best of their ability. Their duties include protecting the assets of the business and the shareholders’ interests.
In order to demonstrate that directors have fulfilled their legal responsibilities, they must keep adequate records, file reports and accounts. They must treat the company as their employer, rather than withdrawing profits as if the company’s finances are their own.
A company is taxed on its profits based on the amount earned in each accounting period. Individuals are only taxed when either they receive salaries as directors or a distribution of profits as dividends as shareholders.
Filing Information with Companies House
Certain directors and shareholders details are required to be filed with Companies House, where they are available to the public. The directors must ensure company accounts are also filed annually at Companies House. A Confirmation Statement is also required annually to ensure that the company’s statutory records are kept up to date.
- A company may be a ‘single member’ company, which is owned by one individual who is both director and secretary.
- In the event of a company’s insolvency, the shareholders will generally find that their shares are worthless. They lose the capital that they have invested in them. If any amount of share capital is unpaid, the shareholders will have to settle this.
- In the event of a company’s insolvency, its directors may have to account to creditors if it is proved that they have suffered a financial loss as a result of their actions.
From time to time shareholders and officeholders may fall out. For this reason, it is essential to draw up a shareholder’s agreement and a director’s service contract.
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As part of our Company Formation Service, we can offer you all the advice you need to help you choose the right trading vehicle for your business. We’ll guide you through the process, making it as easy as possible to turn your business idea into a reality.
And to ensure your business stays on on the right track, we also offer a full range of Accountancy Services.
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