So. You’ve come up with the best business idea of the year, you’ve sounded it out with your friends, you’ve decided to go for it. The big question is how to get started.
One thing you need to think about right at the start is how to structure your business. Do you want to register with Companies House and set up a limited company? Do you want to avoid all the hassle and just function as yourself – known as being a “sole trader“? Or are you going into business with other people and therefore looking at a partnership? This blog will look at the advantages and disadvantages of each option.
Things you need to consider include:
- How tax effective is it?
- What risks are there?
- How complicated is it?
The below assumes you do not have other income.
1. Sole Trader
This is the easiest way to get started. All you need to do is to contact HM Revenue & Customs and let them know that you are now self employed (note you need to do that even if you are also employed by another company).
- How tax effective: fine if you are making profits below the personal allowance (£10,000 for 2014-15). If your profits will be higher then consider setting up a limited company
- What risks are there: you have unlimited liability – so if it all goes wrong, all your personal assets could be at risk, including your house
- How complicated: the annual compliance requirements for a sole trader are straight forward. You do not need to publish accounts, all you are required to do is to submit a self assessment tax return once a year (deadline 31 January if completing online). You are taxed on your profits as income, and are liable to Class 2 and potentially Class 4 National Insurance Contributions.
This is very similar to being a sole trader, except you are in business with one or more other people. There is no requirement to have a formal partnership agreement, but you should definitely consider having one as it could avoid problems in the future.
- How tax effective: again fine if you are each making profits below the personal allowance (£10,000 for 2014-15) once the profits are allocated to each partner. If your profits will be higher then consider setting up a limited company
- What risks are there: each partner can be held personally responsible for all business debts, even if the debt was caused by another partner. And unless you structure your partnership as a limited liability partnership, you again haveunlimited liability so each partner risks all of their personal assets if things go wrong.
- How complicated: In addition to the sole trader requirements, you also need to notify HMRC that you have set up a partnership, and will have to complete a partnership tax return in addition to your own self assessment tax return
3. Limited Company
A limited company is a separate legal structure. In order to set up a limited company you will have to register it with Companies House. A company issues shares, so if you are in business with one or more other people, you can decide up front how many shares you are each going to own.
- How tax effective: The company will have to pay corporation tax (at 20% up to £300,000) on its profits. You will have much more flexibility on ways to take profits out of the company, which means you can do so in a much more tax effective way – i.e. you can pay less tax than you would have done as a sole trader. Most company owners take some money out as salary (which means the company is an employer, has to pay employers National Insurance, and has to complete PAYE returns), and some money out as dividends. Dividends are taxed at a lower rate than trading or employment income
- What risks are there: You immediately separate yourself (and your personal assets) from the company. If something does go wrong, your maximum liability is the amount of money you have invested in the company
- How complicated: the regulatory requirements for a limited company are much more onerous than for a sole trader or partnership. The company has to submit an annual return to Companies House, and has to prepare and publish annual statutory accounts. In addition a corporation tax self assessment return has to be filed with HMRC.
The right answer depends on your circumstances. If you expect your profits not to be significant, then set up as a sole trader, or partnership if you are going into business with one or more other people. If you expect your profits to be above the personal allowance (£10,000 for 2014-15) then consider setting up a limited company.
Project your expected profits for your first couple of years in business to see whether your profits will be high enough to consider setting up a limited company. If they are then you need to think about the extra paperwork required for a limited company. If in doubt, seek advice!