When starting a new business a decision has to be taken as to how the business will be structured. There are various options. Each option not only has its own implications for tax purposes but of course, each option also has different legal/compliance requirements and also presents to potential clients and to the public in different ways.
You need to be aware of the different options available to you when starting your own business so that you can make an informed decision as to which option is likely to be best for you.
We will therefore look at each of the different options in turn.
Many new businesses start out as Sole Traders because it is the easiest option, especially when the business just consists of the one person. Basically the business is structured around you – you are responsible for the business’s liability and debts but you also retain full control of the business and its profits.
The sole trader is the easiest option because there are no formal or legal requirements for setting up the business, also making this the cheapest option.
Tax for Sole Traders Is also straight forward because the business and the sole trader are considered to be just the one legal identity and so you pay the business tax, as part of your own tax, through your individual tax number.
Although most sole traders are individuals who are in business alone, there is nothing to stop a sole trader from having employees, they just have to register as an employer with the IRD.
When doing the business accounts it is important that a sole trader keeps their legitimate business expenses separate from their personal living expenses and for this reason it is beneficial to have a separate business bank account.
The one thing that you can’t do as a sole trader is protect your business name. You can however trade mark your brand as protection.
A partnership is when two or more individuals or entities join together to form a business. A formal partnership agreement is drawn up and this outlines that share of responsibilities, profits/losses and liabilities.
In contrast to a business a partnership is made up of individuals/entities who agree to pool their resources and/or skills into one collective offering. There are no shares because the business doesn’t exist as a legal entity.
Potentially the major disadvantage to a partnership is that partners can be held liable for business debts incurred by their partners.
Although a partnership is required to have its own tax number the partnership itself is not taxed. Rather each individual partner pays tax on their share of the profits through their individual tax returns.
Although any individuals or entities can enter into partnerships they are traditionally used by groups of professionals such as Doctors, Lawyers, Architects and Accountants.
Companies are separate legal entities to their shareholders (owners). They have to be registered for incorporation with the Companies House and declare their director and shareholder details. There are two types of company, private and public. Private companies have their shares owned within a private group (e.g. an individual or a family) while the shares of a public company are listed on the stock exchange.
Shareholders in a company have limited liability which means that they can lose the value of their shares in a business but that is all. They’re not responsible for any other debts or liabilities that a company has.
As the company is a separate entity it owns all its own assets and liabilities and can potentially continue trading regardless of change of ownership.
Shareholders of a business are taxed separately to that business. The income that the shareholders receive from the business can either be paid as a salary or it can be paid as a dividend (or as a combination of the two). Salaries are treated as a business expense and so are deducted before tax whereas dividends are deducted after a company’s tax liabilities have been calculated and paid.
A company is taxed in its own right and there is a designated company tax rate. Any losses are carried forward to be offset against future year profits.
Shareholders can receive salaries with PAYE deducted or can opt for shareholder salaries where the tax is not deducted at the time it is paid, however, with the latter option the shareholders will have to pay the tax at a later date.
Look Through Companies (LTC)
A company that has five or fewer shareholders can apply to the Inland Revenue to become a Look Through Company.
While the official designation of a Look Through Company remains the same, i.e. a Limited Company registered with Companies House, what changes for a look through company is the tax treatment.
Rather than the company itself paying tax at the company tax rate, the profits or losses flow down to the shareholders (the same as with sole traders and Partnerships) and it is the shareholders who pay the tax at their individual tax rates. Losses can either be carried forward by the LTC or can be used by the shareholders to offset their own tax liabilities.