Limited company or sole trader - what's the best legal status for your company?

When you set your company up, you need to decide at an early stage how you intend to structure it as your status can have both legal and practical implications.

Sole Trader

A sole trader is someone who is in business on his or her own account. If you choose to be a sole trader you will be self-employed and personally liable for any debts the business incurs. On the upside, you get to keep the profits you make.

General requirements

• You must pay income tax on any profits your business makes

• You need to complete a self-assessment tax return each year, detailing your income and expenses. You also have to keep records of all your income and expenses

• You must register as self-employed with HM Revenue and Customs (HMRC), there is a penalty of £100 if you fail to register within the first 3 months of trading

• You need to register for VAT if your turnover is going to be more than £60,000 a year. This means you’ll charge VAT on all your good or services, and will have to complete and submit a VAT return to HMRC each year
• You’ll be taxed on the profits you make (as this is your income) in the form of National Insurance Contributions (NICs), either Class 2 or Class 4. The HMRC website has details of current rates.
  
  

Partnership

A partnership is a business arrangement where 2 or more people (usually up to a maximum of 20) are self-employed and in business together to make a profit. All partners share the business costs, profits and debts – regardless of who incurred the debt or made the profit. Partnerships work well when each partner brings a different skill/area of expertise to the business and the workload is divided up to reflect each of the partners’ strengths.

General requirements

• Individual partners and the partnership need to complete a self-assessment tax return each year, detailing their income and expenses. They also have to keep records of all your income and expenses

• Each partner must register as self-employed with HM Revenue & Customs, there is a penalty of £100 if you fail to register within the first 3 months of trading

• The partnership should register for VAT (if their turnover is going to be more than £60,000 a year). This means they’ll charge VAT on all goods or services, and will have to complete and submit a VAT return to HMRC each year

• Partners are taxed on a share of the profits (this is their income) in the form of National Insurance Contributions (NICs), either Class 2 or Class 4. The HMRC website has details of current rates.

 

Limited Liability Company (LLC)

A limited company is one whose shareholders (members or owners) have limited liability to the company's debts. Their liability is restricted to the value of the shares that they own or the guarantees that they sign up to, for example a loan they have guaranteed.

A limited company is a separate legal entity. It can sue and be sued and will continue to exist even if the members or owners die or resign. It can only be folded if it is wound up or struck off the register by Companies House.

In return for these benefits, limited companies are governed by tighter rules and regulations than partnerships or sole traders.

General requirements

• Registration with Companies House is required and accounts must be filed each year

• A company must be made up of a minimum of one director and a company secretary

• Company management decisions must be made by a director or the board of directors

• A company is required to pay corporation tax and each year to file a return with HM Revenue and Customs

• All employees and directors have to pay income tax aswell as Class 1 National Insurance Contributions (NICs)

• Each year a 363s form will be sent to the company (before the anniversary of incorporation). This form must be checked, any changes should be made and then it should be returned to Companies House along with the required monies

• Should the structure or management of the company change in any way Companies House must be notified, either by a director or company secretary

• Limited Liability Companies pay Corporation Tax at a minimum of 19% 

 

Limited Liability Partnership (LLP)

This legal business structure aims to combine the flexibility of a partnership arrangement with the benefits of limited liability. The main differences between a Limited Liability Company and an LLP are that that the latter is taxed as a partnership rather than as a corporation and that it has more organisational freedom. An LLP's duties in return for the limited liability status are similar to those applying to limited companies.

General requirements

• File annual accounts and returns at Companies House, facing penalties if they are late
• Each year a 363s form will be sent to the company (before the anniversary of incorporation). This form must be checked, any changes should be made and then it should be returned to Companies House along with the required monies 
• Individual partners and the partnership need to complete a self-assessment tax return each year, detailing income and expenses. You also have to keep records of all your income and expenses
• Have at least 2 ‘designated members’ – these members have more responsibilities than other company members and they will be held accountable for failing to fulfil them
• Notify any changes to members, officers or registered office address
• Partnership members get taxed based on the share of the profits they receive. They also pay National Insurance Contributions.

 

You’ve got your structure, now what about your business name?

You can register your business name with the National Business Register, but there are a couple of things you should bear in mind when selecting your business name.

• Don’t pick one that is similar to another well known business name – as you could face legal action from the other business owner. Check your chosen name with the National Business Register, the Patent Office, Companies House Trade Marks Register

• There are limits on using certain words under the Business Names Act 1985 and the Company and Business Names Regulations ACT 1981. To find out which words have restrictions on them and for more information visit the Companies House website or the National Business Register.

 

Taking on employees

If you decide to take on staff then you’ll need to put a PAYE system in place, as you'll start collecting income tax and NICs from any employees and pay these to HM Revenue and Customs on time.