Unfortunately there is no “one size fits all” answer to this question and it does vary from situation to situation.
If you set up a business you have three main options in the UK as to how to structure it:
1) As a sole trader (or partnership if there is more than one founder/owner)
2) As a limited company
3) As a limited liability partnership
Most business would choose either option one or two. Limited liability partnerships are normally used by specific types of businesses (such as lawyers and accountants). In essence, they have the limited liability benefits that limited companies do, but they are taxed like a partnership.
On that basis, let’s focus on the two main scenarios – sole trader/partnership and limited companies – and see what the characteristics, pros and cons of each are:
Sole trader/partnership
Characteristics
- No limited liability – the business is not a separate legal entity from its owner(s).
- Owner(s) are taxed on the profits made personally. Personal income tax rates go up to 45% for earnings over £150,000 per annum.
Pros
- No public filing of accounts. The business’ financial records do not appear on public record.
- If the business is loss making you will be able to offset these losses against your any other income you have personally, so potentially reducing the personal tax you will need to pay in that period.
Cons
- No limitation of liability. The owner(s) are personally liable for any liabilities the business has and their personal assets could be at risk.
- All profits are distributed and taxed on the owner(s).
- No flexibility in how the owners get remunerated by the business. All profits taxed under income tax rates on the owner(s).
- Does not offer a flexible structure to obtain further external investment.
- May not provide a credible image of the business in the marketplace.
Limited company
Characteristics
- Limited liability – the business is a separate legal entity from its shareholders/directors.
- The company pays Corporate Tax on the profits made in the business. Current corporate tax rate is 20%, reducing to 18% in 2020.
Pros
- Limitation of liability – the owners are not held liable for any of the liabilities of the business.
- Provides flexibility of how the founders are remunerated. They can have salary, dividends and also be provided with benefits by the business eg. pension contributions, private medical cover etc. All of which provides greater tax planning opportunities.
- Being a registered limited company gives the business an impression of scale and being an established business, potentially access to a greater customer base that would not do business with a sole trader.
- A limited company provides a structure whereby third party investors can invest easily in the entity.
Cons
- The company’s accounts need to be filed on public record each year, within nine months of the year end.
- Running a company is more costly with annual public filings and financial statements needing to be prepared under the Companies Act.
- What option is best for you will depend on your specific business, the risks involved, the size of your business and how profitable it is. Getting the choice of structure right is important and doesn’t just come down to tax, so do get professional advice.
To contact Kreston Reeves for further advice, call +44 (0)330 124 1399 or fill in their online form.