So you have decided to work for yourself, but after reading many postings on forums today it is apparent that a lot of you are not getting the support and advice you need when starting in business and this is very worrying, no wonder we have such a high mortality rate amongst new business here in the UK.
Here is a quick guide the different types of legal status available to you when you start to work for yourself, firstly I want to make it very clear that the legal entity you choose cannot be decided by just reading this posting, you really need to seek professional advice, but this posting may at least give you some basic guidance so you know what questions to ask any potential adviser.
The actual legal status that your business takes may be decided by the industry you are working in. It is not uncommon for some industries to only accept people who work through a limited company, there are reasons for this, but they are not relevant to this posting.
The four types of status I am going to give you details on are:
- Sole trader
- Limit Liability Partnership
- Limited Company
This is by far the easiest type of status to set up. A sole trader aka a sole proprietorship business, is one of the most common types operated by an individual, this may have changed more recently as many of you will know everyone seems to be a limited company these days, even your window cleaner!
The downside to this type of entity is that the business and you are considered the same under law. That means if your business is sued, then potentially everything you own is at risk to!
Another downside, if you make more profits than you draw out, you are still taxed on all the profit irrespective of whether you have taken the money, and with a 40% tax band this can be expensive.
However, a big advantage, and one which I think is why so many opt for this status, is that this is the easiest form of business to own and operate because it does not require any specific legal organization (once registered with the various government departments). The HMRC website also gives some useful guidance on how to register as self employed.
This is where two or more individuals join together to run a business. Like the sole proprietor status you are still liable for any debts personally, but this time they can be shared with your fellow partners.
A partnership is a legal entity that is recognized under law, this means it can sign contracts, obtain credit, anything a sole trader can do, but in this case anyone of the partners can sign and therefore legally bind everyone. So, make sure you know who you are going into business with!
If you are entering into a partnership with someone then you should at the outset have a partnership agreement drawn up, this will detail amongst other things, the authority of the partners, how profits/losses are to be shared, rights and responsibilities of all partners. It is worth noting, once the partnership agreement has been drawn up and signed, it can be modified at a later date.
As with a sole trader business, the individuals are taxed on their share of the partnership profits, regardless of whether they have taken all this money out.
Limited Liability Partnership ‘LLP’
The LLP requires a more formal approach, and entails more ‘red tape’ than the above two types of trading entity.
This status shares some of the characteristics with both a partnership and a limited company. Members of the LLP are registered at Companies House as members. LLP affords limited liability to its members, but is taxed the same as a partnership. An LLP is a separate legal entity from its members. It may enter into contracts etc and sue and be sued in its own name.
For the benefit of this limited liability status for the members there is a downside, with either a sole proprietorship or partnership no one other than those party to the accounts knows anything about your businesses financial position, with an LLP you have to file accounts at Companies House where they are open to scrutiny by anyone who wishes to pay to see them, including your next door neighbour!
There is a lot more ‘red tape’ with an LLP but in the right circumstances they can be a very good and very tax efficient vehicle. For more on LLP’s visit the Companies House website.
A limited company is a separate legal entity that has substantially all of the legal rights of an individual. This gives you protection, it is the company that contracts with third parties and therefore if anyone is sued it will usually be the company and not you as the individual.
A limited company must obtain approval from Companies House to use its proposed name.
A limited company must also adopt and file its Memorandum and Articles of Association, these govern its rights and obligations to its shareholders, directors and officers.
A limited company must also file annual tax returns (“corporation” tax returns) with the Revenue just like an individual.
Apart from the protection offered via this status, a limited company has a low starting tax rate of just 20%, it will pay this on all it’s profits (up to £300,000, beyond this the rate increases to the full rate of 21% (31/3/2015), now this is attractive if you make enough to pay tax at 40% or even 45% as either a sole trader, partnership or LLP but don’t take all the profits out to live on.
So you can see, there is a lot to think about, not only what ‘red tape’ is involved with each status, but which status suits your needs for protection, tax, flexibility and the list goes on.
Please don’t try and go it alone, most advisers will give you a free hour to discuss the basics, spending a bit of money now really can save you a lot further down the line.