Save tax

According to Clive Sparks, director at tax consultancy Ledger Spark, a limited company can offer attractive benefits in terms of tax. A company has a separate identity from its owners. Corporation tax is payable on the retained profits, but these rates are particularly favourable for companies with profits of up to £1.5 million.

“For the majority of people, a limited company will save tax. The corporation tax rate is 19% compared to a personal one of 22%, and another reason is national insurance contributions (NICs),” says Sparks.

A company may pay out some or all of the profits in the form of dividends to the shareholder (that is, yourself) and it’s worth noting that there are no NICs to pay on dividends. The business of a partnership does not have a separate identity from the individuals concerned. Your profits will be added to any other taxable income you have and subject to income tax if the total comes to more than your personal allowance, which at present is usually around £4,615.

Stephen Pegge, head of external communications at Lloyds TSB, says: “With a limited company, there is more flexibility in terms of tax planning than with a partnership.”

Profit and loss issues

Whether the business will be profitable or make a loss is also an important consideration. If you are in a partnership, you can deduct losses from the future profits of the same trade, other income or capital gains either in the year of the loss and the year before (this includes any personal income you may have), and other income in the previous three years if the losses occur in the first four years of the business.

For a limited company, the relief is not so generous. Losses can be deducted from company profits of the previous year, future profits of the company and any capital gains the company makes.

“When you are deciding your business entity, it is very important that you seek professional advice. I would recommend going to an accountant and talking through the various options. Some forms will have certain advantages over others, but you need to weigh these up and see what is best for you,” says Nigel Lander, a specialist finance adviser for Business Link.

Lander also suggests that the business form you choose can to a certain extent depend on what image you want to project. Although setting up as a limited company involves dealing with more regulations, Lander says that businesses often prefer to deal with limited companies as these seem more ‘grown up’ in status.

A limited company will offer you advantages such as limited liability, greater credibility and lower tax. A partnership will offer better tax treatment of losses and has less heavy rules when it comes to accounts.

Whichever form you choose it is most important that you have a very clear agreement, either a partnership or a shareholder agreement, on what each of you expects from the other in terms of work, salary, dividends (or profit share), control and decision-making and so on. The arrangement you are outlining is loose, so that there could well be disagreements at some later stage, and a clear, legal agreement will help you sort them out.