You’ve made the brave decision to go ahead with your business idea and work for yourself. This is great news. It also means your to-do list is endless. One item that needs to be on your list, is choosing the right legal structure for you. This process can be daunting. I outline below, in basic straight forward terms what the options are and why you would want to choose one over the other. The good news is, if the one you’ve chosen does not turn out to be the right one for you, you are allowed to change it.
I am going to compare registering as a Sole Trader versus a Private Limited company as these are the two options you most likely will need to choose between.
SOLE TRADER
What is it?
- Classed as self-employed.
- You are allowed to have staff (just because you are a sole trader doesn’t mean you have to do all the work yourself).
- You are personally responsible for the losses your business makes.
- In the same vein, you retain all profits of the business.
The paperwork.
- You need to complete an annual self assessment tax return.
- You have to pay income tax on your profits.
- You need to pay national insurance.
- You need to register for VAT if takings are more than £82K a year.
Why choose this option?
- You are unsure about launching your idea and want to test the waters first without making too much of a big commitment. Remember, you can change type later.
- Lower accountancy fees and admin expenses.
- You have privacy. There is no need to declare to the world how much you are making, unlike a limited company.
LIMITED COMPANY
What is it?
- A Limited Company is registered at Companies House and has a corporate personality. It is a legal entity. It can be further divided into private and public, but if you are a start-up, I’m going to assume you are interested in ‘private limited company’ as an option and are not quite ready to go public. One step at a time!
- The company is responsible in its own right – finances are separate to your personal finances.
- Profits are owned by the company after paying Corporation tax.
- Company can share its profits.
- “Members” are people who own shares in the company.
- “Directors” are responsible for running the company.
- The legal responsibility of running the company lies with the directors.
The paperwork.
- You need to file annual statutory accounts (it is a criminal offence not to do so).
- You need to send Companies House an annual return.
- You need to send HMRC an annual company tax return.
- As above, you are required to be VAT registered if takings exceed £82K. See advice below re flat rate scheme.
- A director of the company needs to fill in a self assessment tax return and pay any income tax and NI if paid a salary by the company.
Why choose this option?
The “limited” gives the company a bit more weight and appears to be bigger giving more confidence to potential investors, clients and suppliers. Banks also tend to favour limited companies.
Tax savings. Dividends of a limited company are subject to lower tax rates than self-employment income. (0% tax for basic rate tax payers and 10% for higher and additional rate tax payers). You can distribute dividends after 20% corp tax has been paid on profits.
Risk. Shareholders have no personal liability beyond the amount paid for the shares. If you do not succeed, and go bankrupt, it is the company that goes bankrupt, not you.
Raising finance. There is the option to raise funds by selling shares.
Top Tip
- Although you don’t have to register for VAT until you reach £82K income, you may want to register for it anyway. If you have very few purchases, for instance if you are a consultant, then you can register for the flat rate VAT scheme. Under this scheme, you cannot claim back VAT on purchases (who cares? You don’t have any anyway) and although you can charge out 20% VAT you can pay back less to the government. Exact percentage depends on what your business sells exactly. Essentially, you get to keep some of the VAT. Hooray!
This is of course a basic overview and I am by no means a tax expert. But hopefully this clears things up a bit if you find yourself at this stage of your start-up set up.