This is a sample excerpt from our newly updated Business Tax Book - 101 Business Tax Tips Save 40% Today
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There are various ways in which businesses can be structured, and it is important that the structure that is chosen is the right one for the business.
There are four main options:
sole trader;
partnership;
limited liability partnership; and
limited company.
The choice of business vehicle affects the type of taxes you pay, your liability for business debts and the legal and administrative requirements imposed on the business. It will also affect the way in which business decisions are made and the sources of finance available to the business.
In deciding on the right structure for the business, it is necessary to take account of all relevant factors and also your attitude to risk.
For example, a sole trader is the simplest set-up and the proprietor gets to keep all of the profits. However, he or she is also liable for all of the business debts. The sole trader is taxed on his or her total income after deducting his or her personal allowances – the profits of the business are not taxed separately but form part of the sole trader’s taxable income, together with income from other sources, such as any employment or investment income. A sole trader must also pay Class 4 National Insurance contributions (NICs) if their profits exceed the lower profits limit.
A limited company is more complicated to set up and administer, but the shareholders’ liability is limited to the amount of capital that they own – a major plus. The company is taxed in its own right, and any profits that are extracted from the company will be taxed on the recipients. The tax position of the company is separate from that of the individual shareholders. The company must file annual accounts and an annual confirmation statement at Companies House. They must also comply with obligations regarding their registered office address and the provision of an email address. Being a director of a limited company also confers certain statutory duties.
Example
Bill wants to set up his own business. He has some money to invest but does not want to risk losing his family home if the business fails.
He is also keen to present a professional image to potential customers to help him win new business.
Having considered all the factors, Bill decides that a limited company is the right vehicle for his business. Limited liability is very important to him and he is prepared to undertake the additional administrative burden associated with a limited company in return for this.
Choose Which Taxes You Pay
The choice of business vehicle will also determine which taxes are paid by your business. Sole traders and partnerships pay income tax on their profits and Class 4 NICs whereas a limited company pays corporation tax. However, there may also be income tax to pay on profits extracted from a limited company, and where those profits are extracted in the form of a salary or bonus, Class 1 NICs. If the company provides benefits in kind, the company may have to pay Class 1A National Insurance, while the benefit may be taxable in the hands of the recipient.
The profits from a sole trader’s business and a partner’s share of partnership profits are taken into account in working out his or her overall income tax liability, together with income from other sources, such as any employment income, taxable interest and dividend income. Personal allowances are available to reduce the amount on which tax is charged. To the extent that business profits exceed the proprietor’s personal allowance, they are taxed at 20%, 40% or 45% for taxpayers in the UK excluding Scotland (the Scottish rates of income tax apply to Scottish taxpayers).
By contrast, the taxable profits of a company are taxed at the corporation tax rate, which for the financial year 2024 is between 19% and 25% depending on the level of the company’s profits. Profits extracted from the company as salary or bonus are liable to income tax and also Class 1 NICs. However, salary and bonus payments and the associated employer’s National Insurance are deductible in computing profits chargeable to corporation tax. Likewise, where benefits in kind are provided, the cost of the benefit is deducted in calculating the company’s taxable profits, as is any associated Class 1A National Insurance. There is no corporation tax deduction for dividends, which must be paid out of retained profits, but in the hands of the shareholder, they are tax-free to the extent that the dividend allowance (and any unused personal allowance) is available and otherwise taxed at the relevant dividend rate of tax. Dividends are treated as the top slice of income.
Gains realised by individuals are liable to capital gains tax, whereas a company pays corporation tax on chargeable gains.
All businesses with turnover of VATable goods and services above the VAT registration threshold, set at £90,000 from 1 April 2024, must register for VAT. VAT-registered businesses must comply with the requirements of Making Tax Digital (MTD).
A sole trader and an individual partner in a partnership are self-employed and pay Class 4 contributions on their profits if their profits exceed the lower profits limit. The payment of National Insurance builds up entitlement to the state pension and certain contributory benefits. A National Insurance credit is available where profits are at least equal to the small profits threshold, but below the lower profits limit, providing a qualifying year. Although Class 2 National Insurance contributions are abolished from 6 April 2024, self-employed earners with profits below the small profits threshold can continue to pay voluntary contributions, frozen at the 2023/24 Class 2 rate for 2024/25.
Companies do not pay National Insurance on their profits but must pay employer contributions on payments of earnings made to employees and on taxable benefits in kind.
By choosing the structure for your business, it is also possible to choose which taxes and class of National Insurance you pay – the taxes that are paid vary depending on the structure of the business.
It is important when choosing a structure to consider not only the current rates of tax, but also any future changes where these are known.
The personal allowance is frozen at £12,570 until 6 April 2028, and the basic rate band is to remain at £37,700 for the same time period. The additional rate threshold is set at £125,140 for 2024/25 and will remain at this level until April 2028. The National Insurance thresholds are also frozen for this period.
Example
Richard wants to set up a business. Having considered the options, he decides that being a sole trader is the right decision for him.
Richard will pay income tax on any profits from his business. His income tax liability will depend on his total income from all sources. He will benefit from the personal allowance.
He will pay capital gains tax on any capital gains made from the sale of business assets, etc. where his net chargeable gains for the tax year exceed the annual exempt amount.
He will also pay Class 4 contributions on his profits where his profits exceed the lower profits limit.
If his turnover exceeds the VAT registration threshold, he must also register for VAT. If his turnover is below this level, he can register voluntarily as this will allow him to recover any VAT suffered, although he must also charge VAT on any VATable supplies that he makes.
