Selecting the right business structure for your startup
Your 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. 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 in order for the entity to remain compliant.
What is a Legal Structure?
In simplest terms, it is a legal structure for 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 UK
Businesses do not realise the importance of a business structure in the success of a company. The right structure enables an enterprise to forge a successful path in a competitive market while keeping in mind legal liabilities and rules which can help them get ahead of the competition. It also helps owners and investors in planning for personal assets, personal liability, calculating and paying personal income tax. All the while preparing the company to grow by helping to raise finance while providing investment incentives to investors investing in their business.
The most commonly used structures vary in terms of how different types of businesses will deal with income, debts, tax, personal tax and profits. Consulting a professional accountant before selecting a structure will give you the liberty 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.
A sole proprietorship is the most common choice for a startup having minimal requirements regarding set up and administration. Just 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 the survey conducted by the UK government.
Owner of a small business as a sole proprietorship is personally responsible for the income tax return compliances. A sole proprietorship does not have to register at Companies House, although owners must notify HMRC.
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. Not only that but they can also claim allowance and self-employment reliefs.
How to Register a Sole Trader Business Structure
Registering a sole proprietorship as a business owner is comparatively easy as compared to other business structures in the UK. 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, this will be affecting income tax returns.
Once you register yourself, HMRC will set up your account for online assessment services after sending you with your 10-digit Unique Taxpayer Reference. If you are working as a contractor or a sub-contractor in the construction industry, you will have to register for the Construction Industry Scheme as well.
In case you were registered for self-assessment tax before, you will have to 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 in order to file and pay income tax, Contributions. It is crucial to notify HMRC of your business as soon as you start it and to understand and note down HMRC’s deadlines. A professional business accountant near you can help you with the registration process to avoid filing deadlines and penalties.
Sole traders can hire employees if they intend; however, they must collect the 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 to avoid RTI penalties of payroll.
Each legal structure of a business has disadvantages as well. 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.
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 trusting a sole trader. In most cases, 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.
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.
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.
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.
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.
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 that the company incurs yet don’t pay.
For the limited partner, the accountability of tax returns and debts are limited by the shares of how much they have contributed to the business and 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 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.
As a general partner, it is your responsibility to register your business. Make sure your business, you and your partner are registered with HMRC separately for tax assessment. If you expect your business sales to be more than £85,000 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 accountants accounting services to ensure you have already prepared for it.
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 numbers of heads as partners. However, these types of partnerships demand at least two designated members. These designated members will be personally liable for any filing and reporting of tax returns.
Limited Liability Partnership is safe as it protects each member’s assets, even if the partners have taken a loan against them to invest in the business.
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.
LLPs are expected to register with Companies House (CH) along with each member registered as self-employed with HMRC. Consulting an accounting firm can help you identify any other requirements you must follow depending on your business industry.
How to Register an LLP Business Structure
You must choose the name for the business that must end with ‘limited liability partnership’ or ‘LLP’. 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.
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.
Designated members are also personally liable for informing and updating CH for any changes in the partnership, business names, or member’s details. They can use a company formation agent who can register these changes.
Last but not the least, an incorporated private company and has ownership of its liabilities and provides shares to owners, a limited liability company LTD. A limited company has two types of systems in itself; it may be limited by shares or limited by guarantee. A limited liability company (LTD) is a separate legal entity and has 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.
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.
Limited by guarantee limited companies must have a director and a guarantor, to run the business. The company directors are the one legally responsible for personal and business liabilities and running the company. Moreover, the directors have to ensure that all accounting reports and records are prepared.
Shareholders in the limited by shares company can get dividends, these dividends are subject to tax. Owners must have a clear understanding of dividend taxation to avoid further complexities in business relations.
How to Register a Limited Company Business Structure
For registration, you must first choose the name for 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 are registering your company in Wales, you may use Welsh equivalents.
You can apply online with Companies House by providing the required set of information. The information will be publicly available, and you must update it every year. The good news is that you can hire a competent accountant to do all this on behalf of you 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.
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 businesses types, you will be ready to move on to creating a Marketing Strategy.
Anam has a degree in accounting from the Prestigious St John’s University, and works as a senior director in Clear House.
Before working in Clear House, Anam worked in various commercial roles, the last one being the VP Operations for a prestigious business organisation,working on improving the organisation’s operational efficiency, growth and high level client management.
Anam manages clients ranging from software companies to large property developers and managers. Notably, she recently worked with a large property development company building large scale developments in London and the surrounding area.