Choosing A Legal Structure
You will need to decide whether you are going to run your business in your own right or through a limited company. There are reasons for and against setting up a limited company and the decision often depends on the type of business you are in.
The size of the business can often influence the decision, and it is not uncommon to see a business set up in somebody’s own name and then switch to a limited company after a year to two.
The most common types of entity are as follows:
- Sole Trader
- Partnership
- Limited Company
Sole Trader
A sole trader is a person who is in business on his or her own account. There are no statutory requirements governing the format of a sole trader’s accounting records, nor is there any need to have them audited. However, it is important that the records are reliable enough to enable accounts to be prepared each year, and for VAT returns to be prepared, if you are VAT registered.
The best system for keeping your books will depend on the size and nature of your business. For some businesses, this will be a simple record, while other businesses may warrant a more sophisticated system. We will be pleased to advise you on the most appropriate method of keeping your records.
Partnership
A partnership exists where two or more individuals enter into business together, in their own right. They will be governed by the Partnership Act 1890, and in more formal partnerships, they may also be governed by a partnership agreement. Each partner may be personally liable for the debts of the partnership and this liability is unlimited. The requirements for accounting records are similar to those of a sole trader, and again no audit is necessary. Sole traders and partnerships pay income tax on their annual profits. This is based on the earnings of the business and is paid regardless of how much the proprietors draw personally from the business during the year.
Limited Company
A limited company, by contrast, pays corporation tax on its profits, rather than income tax. The company is a legal entity in its own right, and is effectively the proprietor of the business. A company must have at least one shareholder (the owner) and at least one director (who manages the business). The directors and shareholders need not be the same people, but in practice, for the vast majority of smaller companies, the directors are also the shareholders. Limited companies are incorporated under the Companies Act 1985, which imposes accounting, reporting and public disclosure requirements. The liability of individual shareholders is limited to the amount of their share capital, except to the extent that personal guarantees have been given to third parties (eg. the bank).
While the company pays corporation tax on its profits, the directors from a personal point of view, have income tax deducted on any salary which they take from the company. Similarly, shareholders may receive a dividend from the company and they too may incur income tax on this. The decision as to whether to incorporate your business as a limited company will be based on commercial as well as tax considerations. This decision is a very important one, and each case is different.
Further points relating specifically to companies are dealt with later in this guide.