Entrepreneurs are often so focused on their product or service that they end up overlooking the actual ownership structure of their venture. Therefore, it would probably be helpful to take a look at the available options, what each means and why it’s something you need to get right before you start.
This structure offers fewest administrative burdens but there are implications for tax and raising finance. You’ll also have unlimited liability, which could mean risking everything in the worst case scenario.
About 407,000 UK businesses are structured in this way, with two or more people setting up jointly. They each own the business, share profits, losses and unlimited liability just like a sole trader. It is quite complex and does require specialist accountancy and legal skills to establish but is a common and often successful formula.
Limited Liability Partnership (LLP)
LLPs are a touch more complex. The audit, returns, winding up and insolvency rules are similar to limited companies but the tax situation is just like partnerships. The added factor here is that partners, as the name suggests, are liable only to the limit of their partnership commitments.
This is a legal entity that is separate from its owners. Ownership can be changed (the company bought and sold) or extra capital raised though the selling of shares (equity), without necessarily affecting the management of the company.
Key areas of difference between these structures
For the first three structures above, the owner(s) are not distinct from the business. The business’s profits are therefore viewed as the owner(s)’ income and are taxed as such. So profits over £32,011 for a sole trader (or per partner in the case of a partnership or LLP) in 2013-14 will be charged at 40%.
For a limited company, profits are subject to corporation tax at 20% up to £300,000, while marginal rates apply between £300,001 and £1.5m, and 23% above £1.5m. However, as a director and shareholder, profits can be drawn as a combination of salary and dividends (subject to profitability) or repayment of a director’s loan account, if in credit. The limited company format and the low rate of corporation tax allow entrepreneurs to make profits and to defer taking the rewards out of the company.
One distinct advantage for small companies is that corporation tax is payable nine months after the end of the accounting year whereas sole traders, partnerships and limited liability partnerships make payments on account during the tax year at the end of January and July. Companies to make a corporation tax return to HM Revenue & Customs (HMRC) every year.
Regulation and accounting
Limited company status has some downsides, perhaps the main one being the additional level of regulation and accounting required.
Sole traders can choose their name freely but Companies House can prevent a particular name being chosen for a limited company, particularly if the name gives a misleading impression of the nature of the company. Businesses wanting to form a limited company either use the services of a company formation agent or their accountant will make the necessary enquiries and complete the formation process. Companies can be bought ‘off the shelf’ and the particulars changed if a company is required urgently. It is also possible to make the initial enquiries regarding a limited company directly with Companies House through its WebCheck system.
An annual return, a snapshot of general information about the company’s directors, secretary, registered address, shareholders and share capital, must be made to Companies House every year, along with the annual financial statements, and also be sent to all shareholders. Accounting records must contain entries showing all money received and expended as well as all assets and liabilities of the company. Those with a turnover in excess of £6.5 million, and/or net assets in excess of £3.25 million or more than 50 employees must have accounts audited.
Notifying HM Revenue & Customs
Companies House automatically notifies HMRC as soon as the company has been formed but sole traders or partnerships must do it themselves. HMRC uses the information to set up a computer record for the company and allocates it a reference number known as a Unique Taxpayer Reference (UTR). HMRC also tells the directors what they need to do if the company has become ‘active’ and suggests other tax implications the company may need to consider.
Apart from the choice of ownership structure for tax purposes, choosing a limited company format is often seen as a statement of intent. Although, initially, finance providers will look behind the corporate person at the individuals supporting the company, once the company has a track record, finance providers will be more likely to treat the company as a credible vehicle for finance. There can be compelling tax advantages to choosing the limited liability format, but it is important not to underestimate the regulatory and legal requirements of choosing particular ownership structures.