You fancy yourself as an entrepreneur, you have the idea, you see the pound signs before your eyes and the dream Ferrari…but what do you really need to know when starting a business? This article does not promise to provide a recipe for guaranteed success, but what it does do is flag some of the tax and National Insurance implications of different business structures.
When it comes to business structures, all are not equal from a tax perspective and the option you choose can ultimately affect how much cash is left in your pocket. As with all business decisions, the right structure for your business will depend on much more than the tax and National Insurance implications and it is essentially to consider all relevant factors. As always, one should not let the tax tail wag the commercial dog!
There are a range of options available when choosing a structure for your business, the main ones being:
•Sole trader – a business owned and run by one person;
•Limited company – a business structure with a legal identity separate from its shareholders and managers. Liability of shareholders is limited;
•Partnership – two or more persons who are in business together and who share profits or losses;
•Limited liability partnership – like a partnership but partners have limited liability.
Other possibilities include franchises and co-operatives.
The following table summarises some of the advantages and disadvantaged of each:
|Structure ||Advantages ||
|Sole trader || •Simple to set up |
•Profits belong to you personally
•Liable for all debts|
•Members liability limited
•Kudos associated with operating through a company
•Can be tax efficient
•More complicated and costly to set up|
•Higher compliance burden – need to comply with company law requirements
•Easy to set up
•Benefit from the skill base of different partners
•Partners jointly and severally liable for partnership debts
•Potential problems if partners disagree
|Limited liability partnership ||•Limited liability ||•More paperwork than for a partnership – need to file financial statements with Companies House |
Tax and National Insurance implications
As mentioned above, the tax and National Insurance implications differ depending on the structure of the business.
Where a person is in business as a sole trader they must pay income tax on their profits. They must also pay Class 2 and Class 4 National Insurance contributions (NIC). When starting in business as a sole trader, it is necessary to let HMRC know and to register your business for tax and National Insurance. Details of how to do this are available on the HMRC website at: www.hmrc.gov.uk/working/intro/self-employed.htm#1.
A self-employed person must complete a tax return. There are separate pages for self-employment. They must also pay flat rate Class 2 NIC of £2.65 per week (unless earnings are below £5,595 in which case it is possible to apply for exemption). Class 4 NIC is also payable on profits once these exceed £7,605 a year (2012/13 figures). The rate is 9% on profits up to £42,475 and 2% thereafter.
Individual partners in a partnership are, like a sole trader, liable for income tax on their share of profits and must pay Class 2 and Class 4 NIC. An individual partner must complete the partnership pages of the self-assessment tax return and the partnership must complete a separate partnership return. The same applies to limited liability partnerships.
A limited company pays corporation tax on its profits. The small profits’ rate is currently 20%. The company must also file a corporation tax return online. However, that is not the end of the story. There will also be tax implications where profits are extracted from the company and this is where tax planning can come in. There are various ways of extracting profits, including paying a salary or paying dividends. If a salary is paid, the employee will be liable to pay income tax on that salary and also employee’s Class 1 NIC. The employer will need to pay secondary Class 1 contributions. Both the salary and employer’s NIC are deductible when computing the company’s profits for tax purposes. By contrast, dividends are paid out of retained profits and are not deductible. However, no National Insurance is payable, and until the recipient’s income exceeds the basic rate limit, no additional tax is payable.
Practical Tip :
In this article it has only been possible to give a brief flavour of the different business structures and it is vital that anyone who is thinking of starting a business takes professional advice from the outset.