Chris Thorpe looks at the various structures from which a business owner can operate.
When looking at how a business is to operate, there are several factors in deciding how that business should be run.
Which one?
A limited company is often the first choice; companies have stood the test of time and can last forever (the Whitechapel Bell Foundry company was the oldest limited company in the UK, having been founded in 1570). More importantly, the company insulates the shareholders’ personal assets from the dangers of the business – that alone is often reason enough.
However, companies do have their downsides; they are not as straightforward as sole traders and partnerships. The profit generated by the company belongs to the company; the owners cannot just take notes from the cashpoint on a Friday as they wish; withdrawals have to be declared. In addition, accounts and returns must be filed for company law purposes.
With sole traders and partnerships, the money belongs to the owners as it arises – they can visit the cash point whenever they like!
What about the tax?
Probably the biggest single factor is tax. With a limited company, withdrawals of profits are generally in the form of salaries and dividends, which attract income tax (and National Insurance contributions with salaries) for the shareholder or director. Rent and interest can also be taken from a company, but also with income tax implications; pension contributions too, where available, but with no adverse tax consequences. So, there’s an element of double taxation with company profits – once under corporation tax, with the same monies taxed again as income for the shareholder. But corporation tax is lower than income tax – currently, a flat rate of 19%, going up to 25% in 2023 with profits above £50,000.
However, the combined effect of corporation and income tax, with efficient planning, can still be less than profits from sole traders and partners being fully subject to the brunt of income tax. If profits are retained within a company, only corporation tax is paid. Some businesses may retain and reinvest their profits rather than withdraw them, so a limited company would attract a lower overall tax liability than a sole trader or partnership. However, becoming a company from an unincorporated entity can attract capital gains tax, and/or stamp duty land tax (or equivalent in Scotland and Wales); whilst reliefs are available, careful planning should be undertaken before making that leap.
Unincorporated business?
A sole trader or partnership is liable to income tax on their profits, irrespective of how much or little they withdraw for the owners. A partnership has the potential added benefit of spreading the tax burden amongst multiple individuals.
For tax purposes, the partners of a partnership are taxed on their profit shares or capital gains (i.e. the partnership itself is tax transparent, although it is a separate entity for VAT purposes).
A partnership is simpler than a company in that there is no need to submit accounts, no dividends to declare, etc. Profit shares can be amended to suit individual partners’ personal tax needs, but even so, the partners’ full share of profits is subject to income tax regardless of what they do with their money, so there’s little incentive to keep it within the business.
Or incorporated business?
Limited companies are separate entities for both legal and tax purposes; partnerships and sole traders are not.
One business structure which is a bit of a hybrid is the limited liability partnership (LLP) – a partnership for tax purposes, but with the limited liability and separate legal entity of a company. LLPs are relatively new (only coming into existence from 2001), but they have proven very popular amongst professionals in particular. Those businesses that want the tax simplicity of a partnership, but the protection of a limited company, may be drawn to the LLP.
Practical tip
Tax is not the only factor to bear in mind with business structures, but plenty of tax can be saved if the business is structured in the right way, coupled with good personal and remuneration tax planning.
