Choosing the right legal structure for a new business
Whether you're just getting started or already turning a healthy profit, it's important to make sure you've got the right legal structure. It's not just a case of ticking the necessary boxes and filling out the right forms. It could also impact how much tax you pay.
What is the best legal structure for a small business?
There are a range of different legal structures available to choose from. Each one has its one advantage and disadvantages, so it’s important to choose a structure that best suits your small business needs. Here are a few examples:
Do you want a legal structure that’s easy to set up, affords you complete control and enables you to make changes easily in the future?
If so, becoming a sole trader could suit you.
Do you want to share the work, risks and profits with another person?
If so, a partnership may be an attractive option.
Are you hoping to attract investment or keep your own personal assets safe should something go wrong?
If so, consider creating a private limited company.
Let’s look in more detail at theses three legal structures and how they could be relevant to your business.
Sole trader legal structure
Running your business as a sole trader is usually the simplest way to get started.
Compared to the other options, there's relatively little paperwork. You'll just need to register with HMRC and fill out a tax return every year.
Despite the misleading name, being a sole trader doesn't prevent you from hiring employees. It just means that you're solely responsible for the business, its records, taxes and its debts.
It’s also worth noting that a sole trader's business isn't considered a separate legal entity. So setting up under this legal structure could mean that your personal assets end up being at risk if your business gets in financial trouble.
Paying tax as a sole trader
Paying tax as a sole trader is fairly straightforward.
After deducting your expenses from your revenue, you're left with your profits. Since those profits are all yours, they're taxed according to your personal allowance and income thresholds. Just as if you were an employee receiving a salary.
Remember that if you’ve invested in capital for your business (like a van, specialist equipment or an office set-up), then you can put your capital allowance to use on your tax return.
Partnership legal structure
Similarly to being a sole trader, the liability of any debts is incurred by you and your partners.
Partnerships are only suitable legal structures for people who already have a strong working relationship.
Being in a partnership results in holding equal responsibility for the actions of other partners. This can lead to various disagreements which may have an impact on the business.
Whatever the strength of your working relationship with you business partner is, signing a partnership agreement at the outset is highly recommended in case of disagreements down the line.
Partnership tax filing
If you decide to run your business as a partnership, you'll need to register with HMRC and name a nominated partner.
The nominated partner is responsible for keeping the business's records and for managing the partnership's tax returns.
They'll need to fill out a partnership tax return every year, and let each partner know what their share of the profits is.
Each partner can then fill out their own self-assessment tax return, just as they would if they were sole traders.
Public Limited company legal structure
If you choose to register with Companies House as a private limited company (ltd), you'll benefit from limited liability. Limited liability means that the business's debts may not become your own personal debts.
A major downside of this legal structure is that you'll have to complete a lot of paperwork. This starts from the formation of the business, and continues through the year and when it comes to finalising the company accounts at the end of each financial year.
As a limited company is seen as a separate entity to its owners, getting paid is more of a complicated process. There are currently three ways to do this:
- Salary (including expenses and benefits) — require you to register the business as an employer with HMRC. More information on this can be found here.
- Dividends — money given from the profits of the business to the shareholders.
- Directors’ loans — taking out money from the business which you have previously invested.
Each of these methods requires appropriate documentation. But regardless of the extensive paperwork, one of the most important benefits of a limited company is that they often appear more credible and professional in the eyes of many people.
This credibility could help you raise finance by selling a percentage of your business or by attracting bigger contracts.
Tax benefits of limited companies
For some businesses, the added complexity of the public limited company legal structure will be compensated for by the increased tax flexibility. An example of this would be the avenues like deferring personal income payments into a new tax year to avoid crossing a higher tax bracket.
As a director and shareholder, you also have the option of balancing your earnings between your salary and dividends in a way that keeps your national insurance and tax bill down.
Minimising your tax bill alone should not be the basis for you choosing a specific legal structure. You should seek advice from a professional before changing your business's legal status.
Tax tips for self-employed businesspeople
When managing your business, it can be difficult to find the time for necessary admin tasks such as completing tax returns can. But making sure your tax returns are accurate and on time doesn't have to be difficult. Here are some simple tips to help you keep on top of your taxes:
- Document everything
- Keep a tax calendar
- Know what's tax deductible
For more in depth tax tips for the self employed click here.