Your qualified tax accountant will emphasise that choosing the right business structure is crucial when you decide to start a business since it relates significantly to tax implications, liabilities, and business scalability.ย A new business owner cannot choose the right business legal structure if they don’t know what it is and the types of business structures. Each legally enforceable structure for a business comes with a different set of legal forms for business operations, which means that different requirements and rules need to be followed for the entity to remain compliant.
What is a Legal Structure?
In simplest terms, it is a legal structure for a business which confirms the legal obligations, the legal position the entity has relative to its owners/investors and how the tax and financial affairs of the entity are dealt with.
Importance of Business Structures in the UKย
Businesses do not realise the importance of a business structure in a company’s success. The right structure enables an enterprise to forge a successful path in a competitive market while keeping legal liabilities and rules in mind, which can help them get ahead of the competition. It also allows owners and investors to plan for personal assets, personal liability, calculating and paying personal income tax. All the while preparing the company to grow by helping raise finance and providing investment incentives to investors investing in their business.ย Many accounting services for startups include advice around selecting a business structure at its very core, enabling the business to tax plan and scale without any hurdles in the future.
The most commonly used structures vary in how different types of businesses will deal with income, debts, tax, personal tax and profits.ย Consulting a professional accountant before selecting a structure will allow you to take this decision with a clear picture and in line with your business vision.
What are the types of Business Structures?
There are four types of business structures for a small business depending on the type and scope of the business and its services or products.ย
Sole trader
A sole proprietorship is the most common choice for a startup with minimal set-up and administration requirements. In 2019, almost 60 per cent, a total of 3.5 million businesses in the UK were doing business as a sole proprietorship, according to a survey conducted by the UK government.ย
The small business owner, as a sole proprietorship, is personally responsible for the income tax return compliances. A sole proprietorship must not register at Companies House, although owners must notify HMRC.ย
A Sole Trader is a business structure that entitles the business owners to the unlimited liability of debts and compliance failures. Sole traders pay a share of the total profits as tax.ย Not only that, but they can also claim allowance andย self-employment relief.ย
How to Register a Sole Trader Business Structure
Registering a sole proprietorship as a business owner is comparatively easy compared to other UK business structures. Owners must register online for self-assessment to pay personal tax and NI. HMRC is changing the tax assessment processes, such as the introduction of Making Tax Digital, which willย affectย income tax returns.ย
Once you register, HMRC will set up your account for online assessment services after sending you your 10-digit Unique Taxpayer Reference. If you are working as a contractor orย sub-contractor in the construction industry, you will also have to register for theย Construction Industry Scheme.
HMRC Deadline
If you were registered for the self-assessment tax before, you must apply for re-registration by filling out CWF1. The CWF1 is a form for registration for personal tax assessment and National Insurance. You must follow the procedure to file and pay income tax and contributions. It is crucial to notify HMRC of your business as soon as you start it and to understand and note down HMRCโs deadlines.ย A professional business accountant near you can help you with the registration process to avoid filing deadlines and penalties.ย
Sole traders can hire employees if they intend; however, they must collect Income Tax and National Insurance Contributions from the employees to later pay to HMRC. Furthermore, you will have to consult an expert accountancy firm that can help you operate the payroll scheme, payroll compliances, and avoid RTI penalties for payroll.ย
Each legal structure of a business has disadvantages as well.ย Sole traders risk their personal assets in the business and may face losses along the way. The pain points for self-employed can be complex but are manageable, nevertheless.ย
Another disadvantage of being a sole trader is the lack of support in terms of financing, as banks and other sources of funding may feel reluctant to trust a sole trader. Usually, sole traders depend on their savings, property, and assets to finance their startups. The taxation is quite easy; however, with the expansion in business, it becomes complex, leading sole traders to seek new opportunities or a different business structure like Partnerships or LTD corporations.
Partnerships
The partnership is an extension to the sole trading structure as a business owner often works in partnership with their spouse, family members or a friend. It works the same as sole trading but has the advantage of two or more individuals. More heads mean more owners liable for the profits and losses accounts under articles of association. The only difference is the ownership of debts and liabilities that each party must own.ย
There are different types of partnerships, most commonly unlimited and limited partnerships. However, in each case, there must be an agreement between the individuals involved to have set roles and responsibilities.ย
This agreement between partners decides how the liabilities, revenues, and ownerships will be split. Furthermore, it also decides the future course of action in case one of the partners decides to leave. Before considering unlimited or limited partnerships with anyone, business owners must have a complete understanding of how to form partnerships.ย
Legal Requirements
The only legal requirement to form partnerships is to have both partners registered for assessment as self-employed separately, and the partnership also registered with HMRC. As for the tax returns, both owners will pay the tax on their share of profits.ย
In the general case, each party is responsible for the debts incurred by the business and any debts incurred by other partners; therefore, you must think carefully before choosing your accomplices.
For the limited partnerships, one of the partners must be a general partner and one a limited one. The responsibility and personal liability of the general partner are more than the limited partner. The former is personally liable for any debts the company incurs yet doesn’t pay.
For the limited partner, the accountability of tax returns and debts is limited by the shares of how much they have contributed to the business and they are not allowed to take irreversible decisions.
How to Register a Partnership
For unlimited partnerships, you must select the name of your business and nominate a liable individual. The last step would be to get registered with HMRC. The registration process for a limited partnership differs as the partners have limited roles. The business name should not have LLP or Public Limited Company PLC or similarity to any existing trademark.ย
As a general partner, it is your responsibility to register your business. Ensure your business, you and your partner are registered with HMRC separately for tax assessment. If you expect your business sales to be more than ยฃ85,000 a year, you must register your business for VAT. HMRC has extended the deadline for Making Tax Digital. So if you have already started a partnership as a Vat-registered business, you must utilise your accounting services to ensure you have already prepared for it.ย
Video: Types of Business Structures
You have four primary options depending on the type and scope of the company, services or products. Watch the video to know more types of Business Structures suitable for your business type.
Limited Liability Partnership LLP
In limited liability partnerships, there are no limits in terms of the number of heads as partners. However, these types of partnerships demand at least two designated members. These designated members will be personally liable for filing and reporting tax returns.ย
LLP is safe as it protects each memberโs assets, even if the partners have taken a loan against them to invest in the business.
Legal Requirements
Same as the unlimited or limited partnership, LLP also requires a partnership agreement for further implications. This agreement clarifies shares of profits for each member, roles, their liabilities. Moreover, the agreement will decide how a member can leave or join the partnership.ย ย
LLPs are expected to register with Companies House (CH), and each member registered as self-employed with HMRC. Consulting an accounting firm can help you identify other requirements depending on your business industry.ย
How to Register an LLP Business Structure
You must choose the name for the business that must end with โlimited liability partnershipโ or โLLPโ. However, if you’re registering your company in Wales, you can use the Welsh equivalents instead. If you are worried about someone else using your business name as their own, you can apply to register a business name as a trademark.ย
You must have a registered physical business address that can have a PO.Box number as well. You can register your LLP electronically using third-party software or ask an agent or a business accountant to do so.ย
Designated members are also personally liable for informing and updating CH for any changes in the partnership, business names, or member details. They can use a company formation agent who can register these changes.
Limited Company
Last but not least, an incorporated private company that has ownership of its liabilities and provides shares to owners is a limited liability company LTD. A limited company has two types of systems; it may be limited by shares or guarantee. A limited liability company (LTD) is a legal entity with separate finances from the owner’s. The only difference would be that the limited-by-shares company has shares and shareholders and can keep any profit it makes.ย
Compared to this, a limited liability company limited by guarantee has guaranteed amounts and has to invest any profits it makes back into the business. Most contractors select limited or umbrella companies to start their set-up as it gives security to their assets.ย
Legal Requirements
Limited by guarantee limited companies must have a director and a guarantor,ย to run the business. The company directors are the ones legally responsible for personal and business liabilities and running the company. Moreover, the directors must ensure that all accounting reports and records are prepared.ย
Shareholders in the limited by-shares company can get dividends, these dividends are subject to tax. Owners must clearly understand dividend taxation to avoid further complexities in business relations.ย
How to Register a Limited Company Business Structure
For registration, you must first choose the name of your company. The name must not have any similarities to other trademarks. It must end with a limited company or Ltd, or the Welsh equivalents. If you register your company in Wales, you may use the Welsh equivalent.ย
You can apply online with Companies House by providing the required information. The information will be publicly available; you must update it yearly. The good news is that you can hire a competent Limited Company Accountant to do all this on your behalf as per the requirements of Companies House.
After the submission, Companies House will register your new limited company within 3-6 hours and you can immediately start trading once you get your incorporation documents. For completed step-by-step details, you can follow our guide on how to start a Limited Liability company.
How to Choose the Best Business Structure?
These were the four types of business legal structures for organisations that business owners use in the UK. The question remains which one is the most suitable for your business type. The answer depends on which business structure meets your needs. If you are still confused about what to choose, you must consult an accountancy firm near you for further guidance. You can also compare the various tax advantages that come when you choose Ltd over a Sole Trader.
Conclusion
Identifying the right UK Business Structures is a crucial part of a business startup. It has implications for business finance and taxation. Once you decide on a corporation structure depending on the various business types, you will be ready to move on to creating a successful business strategy. As this decision can be key to the success of an entity, speaking to an accountant earlier in the businesses journey can be the key difference between success or failure.
