Sole trader or limited liability?
Caan says that it is natural for new business owners to spend their time growing the customer base or getting the product out in the market.
“But if you don’t get your legal, accounting and tax ducks in a row, they can end up taking up an inordinate amount of time and sapping your cash just when you need it the most.”
This includes the legal entity of the business. The options are:
A sole trader is an unincorporated business. This means that it is not registered with Companies House. In most cases, it will have one owner who runs and works in the business on a day-to-day basis. A sole trader is not a company.
A partnership is where two or more come together to carry on a business, trade or other activity. This partnership is in one of two options:
- Traditional unincorporated partnerships
- Limited liability partnerships (LLP)
The traditional partnership has a similar legal status to that of a sole trader — except there is more than one owner.
If a partnership was to borrow money and then default the loan, the partners themselves are seen as liable. Their other business and personal assets can be used to repay the debt.
Limited liability partnership
Limited liability partnerships are incorporated at Companies House and have the protections of limited liability.
Limited liability company
This means that the company’s trade, debts or any other dealings it may enter into are deemed to be its own. Only company assets can be pursued if money is owed.
In theory, shareholders only exposure is any amount of unpaid monies owing for their shares (unpaid share capital).
Which one to use?
Each of these entities has its own particular benefits and drawbacks.
The decision to decide which one to adopt might be the result of weighing up the pros and cons of each choice. Or it might be seeing which one fits the objectives, style and aspirations of the business.
The choice could also be down to picking the norm for the chosen industry, such as LLPs for solicitors.
It might seem obvious that the ideal option would be one of the limited liability options. After all, Sole traders are not seen within the law as separate from the person or people who own the business.
In this case, the assets and liabilities are seen as those of the person owning and running the business. Personal property can be sought to clear debts. This is also the case for traditional partnerships.
So why would anyone want to put themselves at risk? Well, protection always comes at a price. a limited liability company has to:
- Provide stringent reporting. This means submitting annual returns and accounts to Companies House. Also keeping the registrar up to date with any changes within the business. This involves time and extras costs
- Information about the company is held by Companies House and is also available to the public. The directors’ details can be seen by anyone
- Running a limited company can be more tax efficient (with lower tax rates) than any other form of business. Because of this there are stricter rules around accounting
When I owned a limited company, the extra costs were a problem. This didn’t bother me as much as knowing that anyone could see my accounts.
A big advantage of being a limited company is that it can be easier to raise finance from traditional sources.
The following must be set up before registration can take place:
- A suitable company name
- An address for the company
- At least one director
- Details of the company’s shares — you need at least one shareholder
- A SIC code — this identifies what the company does
A limited company can trade as soon as it is registered. This can take 2–10 working days. The minimum registration fee is £12.
Sole traders (or a member of an unincorporated partnership) have their business profits and other personal income taxed via the annual self-assessment.
Profits cannot be deferred to future years. Also, they must pay National Insurance Contributions (NICs) on any profits.
Limited companies are liable for Corporation Tax on their business profits. A limited company can retain profits and distribute them as dividends in future tax years if necessary.
Directors can delay paying income tax on dividends during a good year, and defer paying dividends to the following tax year.
If I set up the Cranfield and Marston Vale Chronicle as a sole trader I would be responsible for paying income tax and National Insurance (NICs).
Unlike registering a limited company before I can trade, I would have until the 5 October of the business’ second tax year to register with the HMRC.
So if I started working as a sole trader in January 2018, I must register as self-employed with HMRC by 5 October, 2018 at the very latest. That’s because January 2018 is in the 2017/18 tax year, so 5 October 2018 will be in your business’ second tax year (2018/19).
What do I do now?
I’m keen on starting a limited company for the tax breaks, asset protection and prestidge.
However, do I need to provide myself with a pension? How do I pay myself? What would an accountant cost?
Before I decide I need to investigate any income streams more thoroughly and then get professional advice.