Legal structures when starting a new business

Online accounting software providers' FreeAgent provide the lowdown on all the different legal structures, starting a new series of accountancy explainers.

When you’re setting up your new business, you may already be focusing on your cash flow forecast and business plan, but have you considered which business structure you should use?  The business structure you choose will affect its legal status, how much tax it pays and when, no matter how small your business is.

• Sole trader vs. limited company: what's the difference?
• Public liability insurance vs general liability insurance
• The self-employeed guide to Self Assessment tax returns
• What type of business insurance do I need?

There are four different business structures in the UK: sole trader, partnership, limited liability partnership (LLP for short) and limited company. Emily Coltman FCA - Chief Accountant to leading online accounting software providers' FreeAgent - explains each structure and how they work:

Sole trader

A sole trader company is the simplest kind of business structure. There’s no legal difference between a sole trader and his or her business. As a sole trader, you are the business as far as the law is concerned.

To start as a sole trader business, you need to register with HMRC as a sole trader by 5th October after the end of the tax year (which runs from 6th April to 5 April the following year). So for example, if you started trading in your business in May 2017, you would need to register with HMRC by 5 October 2018.

Sole traders have to file a Self Assessment tax return every year for the previous tax year. If you file online, you have until the 31st January after the end of the tax year to submit your return. For example, the tax return covering 6 April 2017 to 5 April 2018 must be filed by 31 January 2019. Sole traders don’t have to file their accounts publicly - so, because your tax return is not on the public record, your business’s figures are kept private.

Keep in mind that because a sole trader is not legally different from their business, that means that if your business is sued, you are personally sued, and your own assets – for example, your home and your car – could be taken to pay the debts.

Partnership

A partnership is just like a sole trader except that there is more than one person running the business. There’s no legal difference between the partners and the business itself.

To set up a partnership, you will need to register the business with HMRC. One partner would be the nominated partner responsible for filing tax returns to HMRC, and that person must register the partnership. The other partner(s) must also register separately. The deadlines for registering and for filing tax returns are the same as for sole traders, but not only must the partnership file a tax return, each partner must also file one - so there will be at least three tax returns to file each year. Like a sole trader, partnerships are not required to publicly file their accounts.

Because the partners are legally the same entity as the business, if the business is sued, or one partner vanishes with the partnership’s money or other assets, the other partner or partners could lose their personal assets to pay the business’s debts. That’s why it’s a good idea to draw up a partnership agreement covering important issues like what happens if a partner leaves the business or dies, how much money each partner will put into the business and how much she or he can take out.

Limited Liability Partnership (LLP)

The “limited liability” part of this structure’s name comes from the fact that it’s a separate legal entity from the partners, with a legal identity in its own right. This protects the partners’ own assets if the business is sued, unless they have been guilty of wrongdoing or given personal guarantees.

What’s the catch? Your accounts will be publicly available. An LLP must file accounts every year with Companies House, and a document called an annual return which lists the partners (or “members” for an LLP). These documents are on the public record, so anyone can buy a copy of them for a couple of pounds.

For tax, an LLP is treated the same as a partnership, so it must be registered with HMRC and each partner must register, and then there are tax returns to file each year.

Limited company

In a limited company, the company is a separate legal entity from the people who run it (its directors) and those who own it (its shareholders). For small companies, the directors will often own all the shares, but even if there is only one director who owns all the shares, the company remains a separate legal entity from that person.

This means that it has the same protection of limited liability for the owners’ assets as an LLP but - like an LLP - the quid pro quo is having to file accounts and an annual return at Companies House each year.

Company directors are also subject to legal obligations, for example they must not let the company keep trading if it can’t pay its debts, and they must look after the business’s machinery and other assets.

And, if a company’s costs outweigh its income in its early years, it’s not possible to put those losses against the directors’ other income and claim tax back. The company will only be able to reduce its tax bill by means of the losses once it starts making a profit. For all the other business structures, losses in early years can often be used to claim a tax refund against the owners’ other income.

Despite the additional paperwork involved, running your business through a limited company can often result in a smaller tax and National Insurance bill than for the same business as a sole trader or partnership, which makes it a very popular business structure.

From the outset it’s important to weigh up the advantages and disadvantages of each business structure and decide which best suits your business and your circumstances.

Emily Coltman FCA is Chief Accountant to FreeAgent, who provide a multi-award winning online accounting system to meet the needs of small businesses and freelancers. Try it for free at www.freeagent.com

Simply Business provides tailored insurance for sole traders and limited company insurance.