Many businesses start as sole traders, but this may not be suitable as they grow and employ more people
There’s no one-size-fits-all answer to the right structure, but here’s a quick overview of the main options.
If you started out as a sole trader, the next step is often to look at the option of incorporating as a limited company. A limited company is a separate legal entity from the company directors, which can make business owners more confident about taking risks. If the business is in debt, or fails, you won’t be personally liable for all the money owed – For more information please read this article on Tax briefs, about the possibility of company directors becoming liable for unpaid taxes.
However, in reality, many small businesses will only have a significant potential liability to their bank, which may be covered by a personal guarantee in any case, making limitation of liability less of an issue.
Limited companies are generally perceived as having more credibility when it comes to raising finance or dealing with larger customers and suppliers. There are also tax incentives for investors in companies, such as the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) that are not applicable to sole traders.
Professional fees are generally likely to be higher for a limited company.
From a tax point of view, limited companies pay corporation tax (currently 19% but due to reduce to 17% in April 2020) on their profits, rather than income tax and national insurance contributions for a sole trader.
Shareholders still pay income tax on their salaries and dividends (although at different rates). Changes to the taxation of dividends introduced in 2016 have narrowed the difference between the tax treatment of companies and sole traders, particularly where most of the company profit is taken out of the business each year. However, there will usually be more post-tax profit available to reinvest into the business for a company than for a sole trader.
On the other hand, tax-free pension contributions for the owner can be paid via the company and it can also get some tax breaks, such as research and development tax credits, which a sole trader cannot access. Any money left in the business can often be extracted relatively tax-efficiently as a capital gain when the business is eventually wound up.
Losses can’t be offset against the owner’s other income, as they can for a sole trader, which may be a disadvantage in the early years of the business. Any losses can only be carried forward against future profits of the company.
The main alternative to limited company status is a partnership. These days most partnerships are set up as limited liability partnerships (LLPs). As the name suggests, LLPs limit personal liability to the amount you have invested in the business and any personal guarantees you may have given when raising funds.
Partnerships allow for more diverse ownership of a business, with flexibility of management and pay. They are controlled by their members and partnership agreement. This can mean a greater shared incentive to grow the business and also provide more fundraising options.
There’s also often a credibility benefit as LLPs, like limited companies, have to register at Companies House.
LLPs are ‘tax transparent’. Partners receive profit allocations taken as drawings and are generally treated as selfemployed, subject to HMRC tests – so the taxation is more akin to being a sole trader.
Groups of companies
Some businesses are eventually faced with a question of whether to keep different parts under the umbrella of a single company or establish them as separate businesses.
Different parts could trade independently without any formal legal links, function as divisions within a larger business or function as separate trading entities under the ownership of a holding company.
Any change in set-up is likely to have an effect on how exposed each part of the business is to the success or failure of the others, and the size of stake that shareholders have in the business – issues that will be important to potential investors.
The tax treatment of groups of companies can be fairly complex.
If you’d like to discuss which business structure will best support your growth, please talk to your usual Shipleys Contact.
Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary, if you would like advice or further information, please speak to your usual Shipleys contact.
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