BUSINESS STRUCTURE – WHICH IS BEST FOR YOU?

Written By Chrissie Moncrieffe

Congratulations! You have your business idea! The next important step is to decide what business structure to choose.

“Why does it matter?” you may ask. Well, it’s great that you’ve asked that question.

There are pros and cons to various business structures, and choosing the right one is important from a financial and tax perspective. Your business idea has the potential to generate profit, and you’ll want to retain and enjoy most of that profit while paying only what is necessary in taxes. You may also want reassurance that your personal assets are protected in case of outstanding business debts.

There are three main types of businesses:

Sole Traders

Sole traders are the basic structure of the three. In this business structure, an individual trades as their own entity, with no distinction between the individual and the business. All profit generated is treated as personal income, and there is no separate business tax. Instead, each tax year, the profit generated is subject to personal income tax at rates of 20%, 40%, and 45%, depending on the level of profit generated. For further details on how personal income tax rates apply, see https://www.gov.uk/income-tax-rates. Additionally, you are liable to pay Class 2 and 4 National Insurance, which is subject to the level of profit generated. For more details on National Insurance, see https://www.gov.uk/self-employed-national-insurance-rates.

The main advantages of being a sole trader are the simplicity and lack of business tax, as well as flexibility in relieving losses. Businesses sometimes generate losses in the first year or so of trading, and the sooner you can relieve any losses, the better it is for enhancing cash flow. However, there are distinct disadvantages to operating as a sole trader. One of them is that you are inseparable from the business, meaning you are personally responsible for any outstanding debts and may put your personal assets at risk to settle them. Another disadvantage is that it can be more challenging to raise finance if needed to support your business idea. For details on how to set up as a sole trader, see https://www.gov.uk/set-up-sole-trader.

Partnerships

This is probably the most flexible business structure. If two or more of you would like to start a business together while retaining a sense of individuality, this would be the ideal structure. Partnerships can be formed between individuals as partners and/or limited companies, provided certain conditions are met. Each partner is entitled to a predetermined profit share generated by the partnership. The profit share can be distributed equally among all partners or varied based on the degree of capital contribution, involvement in running the partnership, and other factors. Once the profit share is agreed upon, profits are distributed accordingly each year.

Similar to sole trade, there is no separate business tax for partnerships, and each partner is taxed on their profit share in a similar way to sole traders. For details on how personal income tax rates apply, see https://www.gov.uk/income-tax-rates. Partners are also liable to pay Class 2 and 4 National Insurance. For more information on National Insurance, see https://www.gov.uk/self-employed-national-insurance-rates. Like sole traders, there is no barrier between each partner and their personal assets in case of outstanding debts, unless it is a limited liability partnership structure. Unlike sole trade, partnerships offer more potential to raise finance if needed to support the business idea. For details on how to set up a partnership, please visit https://www.gov.uk/set-up-business-partnership. You can also find details on Limited Liability Partnerships here: https://www.gov.uk/guidance/set-up-and-run-a-limited-liability-partnership-llp.

Limited Companies

Limited companies are ideal for growing and larger businesses. This structure is suitable for businesses that require a separation between the business and the owner. With a limited company structure, you and your business are seen and treated as separate legal entities. Your personal assets are shielded from any company debt. Therefore, as long as there are no individual guarantees for any debt, your personal assets are secure, and you will not be personally responsible for settling any outstanding debts.

Unlike sole traders and partners in a partnership, limited companies must pay corporation tax on all profits generated each year. As of the time of this writing, the corporation tax rates are as follows:

  • Up to £50,000: 19%

  • £50,001 – £200,000: tapered at 26.6%

  • £250,000 and above: 25%

A limited company has various options for tax-efficient remuneration packages that provide flexibility for distributing profits to the owner. The company may also pay Employer’s National Insurance, depending on the remuneration package it adopts. Operating as a limited company offers perks and benefits that reduce the company’s overall corporation tax liability and enhance cash flow for both the business and the owner. It is also easier to raise finance to support your business idea if required. In terms of strategic succession and inheritance tax planning, a limited company offers a greater degree of flexibility. For a step-by-step guide on how to set up a limited company, visit https://www.gov.uk/set-up-limited-company.

WHICH STRUCTURE IS BEST FOR YOU?

Get in touch today, and let’s discuss the right business structure for you and how our tailored services can support you and your business.

More insights and resources to follow soon!

Chrissie Moncrieffe