Forming a company: Choose your trading type

Joanne Harris of accountants Nixon Williams shows you the different options when it comes to setting up on your own and working for yourself

Choosing to go self-employed is a career goal for many working people in the UK. More money, better hours, and a flexible work-life balance are just some of the reasons many people aspire to work for themselves. But should you become a sole trader, form a limited company or even a partnership? Choosing the right trading type is a crucial early decision.

Although the pandemic has caused issues for all types of businesses, it failed to dampen the nation’s entrepreneurial spirits, with the latest ONS data recording more than 4.3m people still registered as being self-employed as of March 2021.

As vaccinations speed up and lockdown restrictions ease, now could be the time to form the business you’ve been planning to set up over the past year.

However, before you start, it’s important to consider the right company trading type for you.

The way in which you register your business can impact your tax, take-home pay, legal responsibilities, and even personal finances, so it’s vital to look at all the options before you make your choice.

Sole trader

Being a sole trader is the single most popular way of trading as business, with almost 60 per cent of UK businesses operating as one.

It’s an easy process to set up, with a simple online registration with HMRC to get started. However, make sure you register before the end of the relevant tax year, as there can be penalties for late registration.

This is the most straightforward means of running a business as it binds you and your company together as one legal entity. You’ll pay tax based on the profits of your business, not on what you’ve drawn from it as payment.

When paying tax, you will need to file a Self-Assessment Tax Return (SATR), where you’ll declare your income and expenses, and be taxed accordingly on your trading profits.

As well as income tax, for the 2021/22 tax year, you’ll also pay £3.05 a week towards Class 2 National Insurance if your profits are above £6,515 and Class 4 National Insurance worked out at 9 per cent on your profits above £9,569 up to £50,270 (and 2 per cent thereafter).

You must register for VAT if your VAT taxable turnover goes over the threshold, currently £85,000.

There is some financial risk involved with operating as a sole trader, as you will be held personally liable for any business debts, meaning if things didn’t go smoothly, you could run up debts, threatening your finances and even your possessions.

Limited company

As sole trader businesses grow, there may come a point where it’s no longer in your best interests – commercially or financially – to remain a sole trader.

By taking on employees, committing to bigger contracts and applying for business loans – or simply seeing a significant increase in earnings – business productivity can increase, along with personal liability if you’re registered as a sole trader.

Any of the above scenarios often act as a stimulus for a transition to becoming a limited company, as this is usually the next logical step, establishing your business as a distinct legal entity. This means in the event of debt, your liability is limited to assets owned only by the company, leaving personal assets such as your house and car protected.

This isn’t the only reason many sole traders move on to go limited, as you can also enjoy the prospect of an established business as well as better opportunities for tax planning.

Making this transition to incorporating your business and becoming a limited company director is relatively straightforward. You’ll need to choose a name, register with Companies House, and register for tax payments like VAT and PAYE with HMRC.

This can all be done online, and there’s plenty of how-to guides out there as well as accountants on hand to take away a lot of this burden for you.

In addition to directors’ responsibilities like keeping records up to date, going limited means you’ll have more flexibility as to how you run your business. For example, you could pay yourself a lower salary and choose to leave money in the business to reinvest or take on additional employees.

As well as paying corporation tax – 19 per cent of any profits made in a financial year – you may need to register for VAT if your turnover is above £85,000. If your salary sits above the threshold of £12,500 per annum, you may also have PAYE income tax as well as National Insurance contributions.

Any dividends paid out of company profits will be taxed at 7.5 per cent at the basic rate, 32.5 per cent at the higher rate and 38.1 per cent at the additional rate, but there is no National Insurance to pay on dividends. It’s worth noting that an accountant will be able to provide advice on how to structure your remuneration in a tax efficient way.

Going limited is a big decision that requires careful and considered planning, but as long as it’s the right decision for you and your business, it can provide a solid foundation from which to grow your business while maintaining a simple approach to tax affairs.

>See also: What is a sole trader? A small business guide

Partnerships

A partnership business is formed when two or more self-employed people work together as owners of a business, sharing the profits and losses. This trading status is close to that of sole traders, as there is unlimited liability, binding the partners’ personal assets with the those of the partnership.

A key part of establishing this type of business is drawing a deed of partnership, which states the amount of capital each partner has contributed, how profits and losses are shared, and who is responsible for bookkeeping. In a partnership, tax rules state that each partner pays tax and National Insurance on their own individual share of the profits.

This means you won’t be going it alone in self-employment and will be able to share responsibility duties between yourself and your business partner while combining capital to create more funds for growth. However, as the business grows, tough decisions may need to be made, which means staying on the same page as your partner is key.

Limited Liability Partnerships

A Limited Liability Partnership (LLP) is a trading status commonly used by solicitors and accountants but can be adopted by businesses from any sector.

An LLP is formed as a separate legal entity from its partners, who will only be held liable for the capital they’ve invested themselves, and any personal guarantees made. An LLP must also be registered with HMRC and can only become a limited liability when the business is making a profit.

To set one up, you’ll need to provide a registered business address and maintain a register of partners, with at least two people taking on responsibility for statutory filing and other legal requirements. LLPs are formed based on an agreement which sets out how the business will work, profit-sharing, how disputes will be resolved and each partner’s individual responsibilities.

Formulating an LLP agreement can be a complex process, with solicitors and accountants often engaged to review documents and ensure they’re satisfactory and within the law. It’s a typical step for established businesspeople looking to form a new company in a market they’re already an expert in.

The advantages include protection of personal assets, a flexible management process and different levels of membership and responsibility, allowing you to increase or slow down your involvement in the business as required. Be aware of the high costs often associated with setting up an LLP.

>See also: 5 best ideas to start a small business post coronavirus

Consider all options before taking the plunge

Going self-employed is a significant milestone in anyone’s life, and one you must consider carefully. The right choice for you depends on the type of business you want to start, your forecasted finances, and goals for the future of the company.

Choosing wisely will be crucial in setting your business up for a successful start, building a solid foundation from which to grow on for years to come.

If you’re close to committing, consider visiting the Companies House website for further information, or speak to a qualified accountant for initial, expert, often free advice on what structure will work best for you to ensure your affairs are in order before your self-employed journey starts.

Joanne Harris is technical commercial manager at specialist contractor, freelancer and sole trader accountancy firm Nixon Williams

Further reading

Five successful business ideas for 2021

 

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