Paul Samrah, Partner at accountancy firm Kingston Smith, explains the various legal structures which are available for start up businesses.

Having made the decision to be your own boss, you then must decide on your choice of legal structure for your new business – sole trader, partnership or company.

It is very important to have a clear analysis of how successful the new organisation might be (in whatever form it takes) before considering the merits of alternative structures. Choosing the wrong structure can be costly both financially and in terms of time to unravel things.

Sole Trader

This is the simplest and cheapest way of trading. There are only a few formalities to complete, the most important of which is to inform HM Revenue & Customs (HMRC).

You must prepare accounts each year and you pay tax and National Insurance (NI) on your profits. This tax is called Schedule D tax and is paid on 31 January and 31 July each year.

Being a sole trader leaves you most exposed if something goes wrong as you have unlimited liability. You are personally legally liable for all business debts. Those debts, if need be, will therefore be met from your own personal finances.

Partnerships

A partnership is an extension of being a sole trader. A group of two or more people come together, pool their talents, clients and business contacts, so that together they can build a more successful business than they would individually.

The partners agree to share the joint profits in a pre-determined percentage. Partnerships are regulated by a Partnership Agreement, or if this is not in place, then by the Partnership Act 1890. It is always advisable, indeed vitally important, that a Partnership Agreement is in place.

Partners are taxed in the same way as sole traders, but only on their own share of the partnership profits. You are jointly and severally liable for the partnership debts, so that if certain partners are unable to pay their share of the partnership debts then those debts fall on the other partners.

The Limited Liability Partnership (LLP) is a new breed of partnership that has been created recently which confirms limitation of financial liability on its members.

The LLP structure retains many features of traditional partnerships including the Schedule D tax regime. However, LLP status requires the accounts to be filed on public record at Companies House.

Companies

Essentially, companies take three basic forms. All carry a ‘Veil of Incorporation’ whereby the company is a distinct entity separate from its employees and shareholders.

This veil protects the stakeholders and staff from any exposure to liability, in all but the most extreme of circumstances. Companies pay Corporation Tax on their profits (currently between 20% and 30%).

Company accounts are placed on public file at Companies House and must contain certain minimum statutory disclosures in accordance with Companies Act legislation.

Dependent on certain criteria, a compulsory audit of the company’s accounts may be required. Companies can raise finance in their own right and any debts belong to the company.

Company governance rules (Memorandum and Articles of Association) are available within the Companies Act. Directors, as stewards for the company, are appointed and are taxed under PAYE.

Private Companies Limited by Shares

The private limited company is the most common form of business structure and will have one or more private shareholders.

The financial risk to shareholders (members) is limited to a maximum of the nominal value of the shares in issue. Shareholders may periodically receive dividends. Should you wish to extract money from the company, you must either pay yourself a dividend (as a shareholder) or a salary (as an employee) under PAYE. 

Private Companies Limited by Guarantee

Guarantee companies are typically in the ‘not for profit’ sector, charities and friendly societies. Instead of shares being issued, the members provide a financial guarantee in the event of the organisation failing.

Guarantee companies can be very restrictive in terms of the way that capital can be distributed and used.

Community Interest Companies (CIC)

In addition, private companies may seek further designation as CICs. These are designed for the charity and public interest sector in which there is a severely restricted ability to distribute reserves and profits other than for the ‘common good’ in the areas defined in its original charter.

CICs are separately regulated which imposes another tier of control over their activity and policy, in addition to the normal statutory regulations.

Companies

New companies can be purchased relatively cheaply, in a ready-made form usually referred to as ‘off the shelf’ companies.

Once you have digested the points and done further research as necessary, you should seek professional advice before deciding on the best structure for your particular situation.

For further information, visit www.kingstonsmith.co.uk

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By Paul Samrah  on   Jul 11,2008

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Keywords

Starting up    business legal structures    business tax    sole trader    HMRC    NI    Companies House    limited company   

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