When setting up your business, one of your first decisions will be choosing which legal structure to use - and thinking about how this structure will affect the way the business runs.
Businesses can be operated either as incorporated entities (generally, that means being a limited company) or unincorporated entities (usually, going self-employed, or setting up a partnership). But which is best for your particular business needs?
Incorporated or unincorporated?
Whether you choose to be incorporated or unincorporated will depend on a number of factors, so it's worth understanding the implications before you make this important decision.
- A limited company is a distinct legal entity that's separate from the owners (shareholders). It can sue and be sued in its own right. A self-employed business on the other hand is legally the same as the person running the business. A partnership is effectively two or more 'self-employed' businesses working together.
- If a limited company can't pay its debts, it can be placed into liquidation and any assets it owns can be sold off. This includes things like vehicles and other equipment.
- If a self-employed business can't pay its debts, the business owner can be made bankrupt and all their assets are potentially available to satisfy the business debts. This can include their home and any other personal property or assets.
- Although a limited company offers better protection in the case of the business failing, banks and other lenders will often insist on personal guarantees from the company directors and shareholders. The end result of this is that personal assets may still be at risk in respect of these debts.
- Nevertheless, the protection of personal assets is one common reason why people choose to operate through a limited company.
- Another common reason for choosing the incorporated route is status. Many people believe that running a business as a limited company gives it a higher professional status - making your business appear larger, or more substantial.
- Some customers will only accept limited companies as suppliers, particularly where you are providing consultancy and other professional services.
- There's a heavier administrative workload for limited companies when compared to unincorporated businesses. For example, limited companies need to file a confirmation statement with Companies House each year, as well as the annual accounts.
- There are also various registers that need to be maintained as well as documentation to pay dividends and salary to the owners. The tax reporting and filing obligations for a company is separate from and in addition to your personal tax obligations. In practice, these requirements are generally managed by your accountant.
Considering the tax structure
The tax structure for limited companies and unincorporated companies are usually very different, with limited companies paying corporation tax on their profits, and self-employed businesses paying personal income tax on their profits.
- A limited company pays tax on its profits, and generally pays a salary and dividends to the directors and owners (often the same individuals). They, in turn, submit their personal tax returns so that their total income can be taxed. Any Pay-As-You-Earn (PAYE) on these salaries is deducted by the company, and taken into account on the shareholder's personal tax return.
- For self-employed individuals, after registration with HMRC the business profits are included on your personal tax return, and the tax and National Insurance liabilities are then calculated accordingly.
- As a rule of thumb, the overall tax and National Insurance liability is likely to be lower when operating through a limited company, but this can change particularly if the business is operating at a tax loss in the early years.
- You'll also need to consider whether your turnover levels make it mandatory to register for Value-Added Tax (VAT) or whether there are any advantages to voluntarily registering for VAT before you reach the threshold (currently £85k per annum).
Get in touch to talk about choosing a legal structure
Choosing the legal structure for your business will have a significant impact on the way it's administered and run.
We'd always suggest seeking professional advice before settling on a business structure for your new enterprise. Although you can change the structure later, it's worth spending the time to get it right initially - giving yourself the best foundations for the early stages of your business.