When starting a new business, one of the most important decisions to be made will be the legal structure under which it operates i.e. sole trader, partnership or limited company.
This is important because the type of structure defines the legal responsibilities of the business owner or owners. It will also affect the management of the business, such as the paperwork required to get started, the taxes that will have to be managed and paid, how any profits are taken from the business, and responsibilities of the owner(s) should the business make a loss. payable as well, based on a percentage of profits – 9% up to £41,450 and 2% thereafter. If national insurance contributions are paid on employment income as well, rebates of Class 2/4 contributions may be available.
These are created where two or more people join together to start a new business. These may be simple partnerships or structured as Limited Liability Partnerships, for example, which are more regulated and have legal rights and obligations in their own right separate from the partners themselves.
In the UK, a new business is usually set up in one of three ways:
• Sole-trader;
• Partnership; or
• Limited company
There are other forms of business, such as LLPs and unincorporate associations, but these relate to more specialist businesses or organisations.
For tax and national insurance purposes, each partner is taxed on their share of partnership profits as though they were a sole-trader. The partnership must file its own tax return each year recording its income and expenses, but the partnership does not pay tax on its profits. Each partner’s own return should record the relevant share of profit only.
This is the simplest business structure where an individual carries out work in their own name, is paid and incurs tax on the income they receive less any business expenses they may incur. A sole-trader is responsible for all debts of the business and is liable for any claims made against it.
A limited company is an entity in its own right, completely separate from the people who own it (its shareholders or members) and the people who run it (its directors). The shareholders and directors may be the same people, but they do not have to be. Someone can be a shareholder without being a director and vice-versa.
Generally, there is no requirement for a sole-trader to produce formal accounts, although the amount of income and, if income exceeds £79,000 currently, details of expenses claimed, must be reported on the individual’s personal tax return. Where income is less than £79,000, only the total value of expenses has to be given. HM Revenue
& Customs should be told of the new business within six months of it starting.
Today, it is very easy and relatively cheap to set up a limited company. Small companies do not have to be audited and, in many respects, there is little difference in the day-to-day administration between a limited company and a soletrader’s business. However, there are some key differences in the liability of the proprietor for debts, or if things go wrong, in year end accounting and tax requirements, and in tax liabilities generally.
The profits or losses of the business are added to the individual’s other income for the tax year and any liability to income tax is calculated on the combined amount. In addition to income tax, if profits exceed £5,725 in 2013/14
Class 2 national insurance contributions are payable at the flat rate of £2.70 per week. Where profits exceed £7,755 in 2013/14 Class 4 national insurance contributions are
Every situation and every business is slightly different.
There are some types of business that may be better run as a company from the outset and others that it is better to start as an unincorporated entity (sole-trader or partnership) and then to transfer into a company at a later date. It may be easier to obtain funding for one type of structure over another, depending on who is providing the funds, or there may be regulatory restrictions on how

a business may be operated. It is important that proper advice is taken from the outset, but some additional matters to consider will include:
• provided the business has been administered correctly, the owners or managers of a limited company may bear no personal responsibility for the debts of the business.
If the venture is not successful and the company cannot meet its debts, or if the company is sued for damages arising from its actions, then the proprietors do not have to pay the debts for the company. If the business is run as an ordinary partnership or as a sole-trader, that protection is not available
• at the end of its accounting year, every company must produce accounts for filing at Companies House. These accounts are available for the public to inspect. In addition, information about the names and addresses of the directors and shareholders of the company are held on record and, again, that information is available for inspection. The accounts have to follow prescribed formats and preparing the accounts will be more expensive than for an unincorporated business
• if there are no other advantages or disadvantages to one form over another, then potential tax liabilities may be the deciding factor. Assuming the business is owned and run by a single individual and taking into consideration the additional administration costs of a company over an unincorporated business, then it is unlikely to be beneficial incorporating a business if taxable profits are less than £25,000 in 2013/14. This considers the effects of income tax, corporation tax and national insurance.
At this level of profit, the saving in tax and national insurance is approximately £1,300, which is equivalent to the additional costs of running a simple business through a limited company. The threshold may be different if the owner/manager has income from other sources and when more than one person is involved in the business.
The choice of business structure depends on many factors and professional advice should be taken to ensure all relevant circumstances are considered in each individual case.
For an informal discussion about your requirements, please contact:
Stephen Farrant (Maidstone)
Marc Farmer (Maidstone)
Or visit www.dsh.co.uk
01622 213704
01622 213755 stephen.farrant@dsh.co.uk marc.farmer@dsh.co.uk
These notes are for guidance only and appropriate specialist advice should be obtained before acting on any information contained herein as it cannot be relied upon as formal advice. No responsibility can be accepted by Day, Smith &
Hunter, Chartered Accountants & Business Advisors, for any loss occasioned to any person or persons, business or other organisation as a result of action taken, or refrained from, in consequence of the contents of this document. Day, Smith
& Hunter is registered to carry on audit work and regulated for a range of business activities by the Institute of Chartered
Accountants in England & Wales.