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Business set up options

Russell Tillbrook

Partner at Barrons

Often when starting a business your first call may well be to the bank. Surely the first step is to set up a business bank account. One simple task easily ticked off! Unlikely. Without doubt the question will be asked “certainly and what trading entity will you be operating?” Until this question is answered you will be unable to open your account and start filling it with those first sales. A business account and any VAT registration requirements can only be undertaken once a decision is made and in the case of a Limited Company the company has been formed and registered at Companies House.

When starting out in business you have a number of options as to how you will operate the business. ‘A simple question’ you say to yourself but unfortunately not always the case. The main options to choose from and by far most popular are sole trader, partnership or Ltd company although there is also the Limited Liability Partnership which combines some of the characteristics of partnerships and Limited companies.

In simple terms a sole trader business consists of yourself trading in your own right. You and the business are one and the same. The benefits of this are that you are free from many of the legal filing requirements of Limited companies. You are simply required to register with HMRC the fact you are trading. This must be done within three months of commencing to trade. Based on this you will be entered into their systems and registered for the self assessment tax regime. Most people will choose to write up their accounts to the following 5th April and from these can complete a personal tax return which will need to be filed by the following 31st January. There is no statutory requirement to produce accounts in a set format and there is no need to register or file accounts on public record. However as a sole trader you will be fully liable for all business liabilities and have no limited liability to protect personal assets should things not go as planned.

Partnerships are similar to sole traders except as the name suggests involve more than one business partner. You will be required to file a partnership tax return in addition to the requirements outlined for a sole trader. You would also need to consider a partnership agreement which will set out amongst other things how profits are split. However you are also still fully liable for all business debts and this goes for any debts built up by the other partners in the business during the course of trade.

A Limited Company however is a separate legal entity. A limited company is registered with Companies House. It issues shares to the business owners and has directors appointed to speak and act on its behalf. A downside with Limited Companies is that it has a number of statutory legal requirements. It will have a set year end and must file accounts at Companies House every year within 9 months of this year end date. These must be in set legal format. The company must also maintain statutory records at companies house and complete its own tax return known as a CT600 which must be filed within 12 months of the company year end. Failure to meet these deadlines can lead to fines and penalties. However the big advantage with a Limited company is it gives limited liability. As long as directors or shareholders do not give personal guarantees on behalf of the company your exposure is limited to your share capital only.

Another significant difference between Sole Traders and Partnerships and Limited Companies is the tax rates you can face. Depending on levels of taxable profit as a sole trader you could face tax rates of up to 45%. However a Limited company in the UK faces a current maximum tax rate of only 20% which is set to fall in the next few years.

With sole traders and partnerships you are taxed on profits as earned in full and not simply on what you draw out of the business. With Limited companies any additional personal tax will only be incurred should you take money out of the company via dividend. With the new tax rules the first £5k in any tax year received via this method per individual will be tax free however. This can make a Limited company a very good tool if you are looking to keep profits within the business to help growth and expansion as you will be able to avoid higher tax rates eating into profits being kept in the business to fund expansion and further business investment.

The choice of trading entity will depend on many individual circumstances and preferences and often a combination of these will ultimately lead to the right choice for your new business. Sitting down with an advisor who can discuss all your business needs and plans and also your own personal circumstances is a vital step in setting up in business and should not be overlooked. Once the decision is made it is also important to monitor the situation. A good adviser will do this on your behalf. Many successful businesses start as a simple sole trader but over time as they develop and needs change will find that they should now look at other options.

In my next article I will look at the process of forming a Limited Company and the options and opportunities that should be considered.