Legal structures: the basics

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Introduction

If you are considering setting up a business, it’s worth thinking carefully about which structure best suits the way that you intend to do business, as this will affect:

• which authorities you have to notify that your business exists
• the tax and National Insurance that you pay
• the records and accounts that you have to keep
• your financial liability if the business runs into trouble
• the ways your business can raise money
• the way management decisions are made about the business

There are several structures to choose from, depending on your situation. This guide will help you understand the differences between them.

If you are not sure which legal structure would best suit your business, you can get advice from an accountant or solicitor.

Becoming a sole trader

Being a sole trader is the simplest way to run a business — it does not involve paying any registration fees, keeping records and accounts is straightforward, and you get to keep all the profits. However, you are personally liable for any debts that your business runs up, which make this a risky option for businesses that need a lot of investment.

Management and raising finance

You make all the decisions on how to manage your business.

You raise money for the business out of your own assets and/or with loans from banks or other lenders.

Records and accounts

You must keep records showing your business income and expenses.

Profits

Any profits go to you.

Tax and National Insurance

As you are self-employed:

• your profits are taxed as income
• you pay fixed-rate Class 2 National Insurance contributions (NICs) regardless of any profits you make
• you pay Class 4 NICs on any profits
• you need to register for Self Assessment and complete a tax return each year

Liability

As a sole trader, you are personally responsible for any debts run up by your business. This means your home or other assets may be at risk if your business runs into trouble.

Partnerships

There are three types of partnership:

• ‘ordinary’ partnerships
• limited partnerships
• limited liability partnerships (LLPs)

Common features of all types of partnership

All three types of partnership have the following features in common:

• two or more persons — ie the partners — share the risks, costs and responsibilities of being in business
• a partner can be an individual or another business, eg a limited company or another partnership
• the profits and gains of the partnership are shared among the partners unless the partnership agreement states otherwise
• each partner is personally responsible for paying tax on their share of the profits and gains, and for their National Insurance contributions
• each partner must register for Self Assessment with HM Revenue & Customs (HMRC) and complete an annual tax return
• a nominated partner must also send HMRC a partnership return
• partners raise money for the business out of their own assets and/or with loans
• the partners themselves usually manage the business, although they can delegate certain responsibilities to employees
• it’s possible to have ‘sleeping’ partners who contribute money to the business but are not involved in running it from day to day
• the partnership must keep records showing business income and expenses

It’s a good idea to draw up a written agreement between the partners. For further advice, consult an accountant or solicitor.

‘Ordinary’ partnerships

An ‘ordinary’ partnership has no legal existence distinct from the partners themselves. If one of the partners resigns, dies or goes bankrupt, the partnership must be dissolved — although the business can still continue.

A partnership is a relatively simple and flexible way for two or more people to own and run a business together.

Ordinary partnerships also have to be registered with HMRC for tax purposes. The nominated partner does this by registering the partnership for Self Assessment.

If the partnership has debts, the partners are jointly liable for any amounts owed and so are equally responsible for paying off the whole debt.

Creditors can claim a partner’s personal assets to pay off any debts — even those debts caused by other partners.

If a partner leaves the partnership, the remaining partners may be liable for the entire debt of the partnership.

Therefore, partners do not enjoy any protection if the business fails.

Limited partnerships

A limited partnership is made up of a mixture of ordinary partners and limited partners.

Limited partnerships must register with Companies House but don’t generally have to make an annual return or file accounts. When they receive the registration Companies House inform HMRC that the limited partnership has been set up. HMRC will set up the partnership’s tax records so there is no need to register with them.

Ordinary partners are jointly liable for any debts owed by the partnership and so are equally responsible for paying off the whole debt.

A limited partner’s liability is limited to the amount of money they have invested in the business and to any personal guarantees they have given to raise finance.

Limited liability partnerships (LLPs)

LLPs must have at least two designated members — the law places extra responsibilities on them.

If for any reason the number of designated members falls to one, every member is deemed to be a designated member.

LLPs must:

• register with Companies House
• send Companies House an annual return
• file accounts with Companies House

When they receive the registration Companies House inform HMRC that the LLP has been set up. HMRC will set up the LLP’s tax records so there is no need to register with them.

A partner’s liability is limited to the amount of money they have invested in the business and to any personal guarantees they have given to raise finance.

This means that members have some protection if the business runs into trouble.

Starting a private company

There are broadly two types of private company:

• private limited company
• private unlimited company

A private limited company may be limited by shares or by guarantee.

Common features of private companies

In relation to set up and administration, a private company:

• Must be registered (incorporated) at Companies House. You can register either via a paper application form or electronically using a third party with access to the necessary software — eg an incorporation agent, software provider or solicitor. Alternatively, if you are a private company limited by shares which is adopting model articles in their entirety, you can incorporate your limited company online with Companies House.
• Does not have to appoint a company secretary but if one is appointed, this must be notified to Companies House.
• Must file it accounts annually with Companies House. The accounts must be audited unless the company is exempt.
• Must send an annual return to Companies House.

You can send your annual return and other documents to Companies House electronically using its WebFiling service.

Both types of private company must also have at least one member and at least one director.

The director or — where there are two or more directors — at least one director must be an individual. Each director who is an individual must be at least 16 years of age.

The director — or the board of directors — make the management decisions. Note that directors may also be shareholders.

Directors must notify Companies House of changes in the structure and management of the business.

Finance comes from shareholders, loans and retained profits. Any profits are usually distributed to shareholders in the form of dividends, apart from profits retained in the business as working capital.

If the company is active, it must tell HM Revenue & Customs (HMRC) that it exists and is liable to Corporation Tax. It must then pay any Corporation Tax that’s due and submit a Company Tax Return to HMRC.

Companies also need to comply with HMRC’s requirements for PAYE for employers, VAT, the Construction Industry Scheme etc.

Private limited companies

Limited companies exist in their own right. This means the company’s finances are separate from the personal finances of their owners.

A company may be limited by shares or limited by guarantee:

• a company is limited by shares if members’ liability is limited to the amount, if any, unpaid on the shares held by them
• a company is limited by guarantee if members’ liability is limited to an amount the members agree to contribute to the company in the event of its being wound up

For a company limited by shares, shareholders are not responsible for the company’s debts unless they have given guarantees — eg a bank loan.

However, they may lose the money they have invested in the company if it fails.

Shareholders may be individuals or other companies. However, shares cannot be offered to the general public.

Private unlimited companies

A company is an unlimited company if there is no limit on the liability of its members.

It may or may not have share capital.

Such companies are rare and usually created for specific reasons. It is strongly recommended you take legal advice before creating one.

Tax and National Insurance for company directors

Company directors are an office holder of the company and therefore regarded as an employed earner for the purposes of paying National Insurance contributions (NICs). As such, company directors must pay both Income Tax and Class 1 NICs on their director’s earnings.

However, while regular employees’ Class 1 NICs are calculated on their monthly or weekly earnings separately, directors’ NICs are calculated on an annual cumulative basis.

Company directors must complete a Self Assessment tax return each year. You will need to give details of the income from your directorship on the employment pages. If you do not usually fill in a tax return you must register for Self Assessment.

Starting a public limited company

Public limited companies (PLCs) exist in their own right. This means the company’s finances are separate from the personal finances of their members.

Set-up

PLCs must:

• Have at least two shareholders.
• Have issued shares to the public to a value of at least £50,000 or the prescribed equivalent in euros before it can trade.
• Be registered (incorporated) at Companies House — you can register either via a paper application form or electronically using a third party with access to the necessary software, eg an incorporation agent, software provider or solicitor.
• Have at least two directors — at least one must be an individual. Each director who is an individual must be at least 16 years of age.
• Have a qualified company secretary.

You can incorporate your limited company online with Companies House. The web incorporation service is used for incorporating a private company, limited by shares, with model articles of association.

Management and raising finance

Businesses that are PLCs are the only type of business that can raise money by selling shares to the general public. Shareholders can be individuals or other companies.

The shares may or may not be traded on the stock exchange.

Finance can also be raised through loans and retained profits.

Note that directors may be asked to give personal guarantees of loans to the company.

A board of directors usually makes the management decisions.

Records and accounts

PLCs must:

• send an annual return to Companies House
• file accounts with Companies House once a year — the accounts must be audited unless the company is exempt

You can send your annual return and other documents to Companies House electronically using its WebFiling service.

Directors must notify Companies House of changes in the structure and management of the business.

Profits

Profits are usually distributed to shareholders in the form of dividends, apart from profits retained in the business as working capital.

Tax and National Insurance

If a PLC has any taxable income or profits, it must tell HM Revenue & Customs (HMRC) that it exists and is liable to Corporation Tax. It must then pay any Corporation Tax that’s due and submit a Company Tax Return to HMRC. A PLC must also comply with HMRC’s requirements for PAYE for employers, VAT, the Construction Industry Scheme etc.

Company directors are an office holder of the company and therefore regarded as an employed earner for the purposes of paying National Insurance contributions (NICs). As such, company directors must pay both income tax and Class 1 NICs on their director’s earnings.

However, while regular employees’ Class 1 NICs are calculated on their monthly or weekly earnings separately, directors’ NICs are calculated on an annual cumulative basis.

Company directors must complete a Self Assessment tax return each year. You will need to give details of the income from your directorship on the employment pages. If you do not usually fill in a tax return you must register for Self Assessment.

Liability

The liability of each member is limited to the amount unpaid on their shares.

Members are not responsible for the company’s debts unless they have given guarantees — eg when taking out a bank loan.

Setting up specific types of limited company

Instead of setting up a ‘standard’ type of public or private company, you could consider setting up a:

• Community Interest Company
• Right-to-manage company
• Societas Europaea or European company

These types of company are subject to company law in the same way as standard public or private companies.

However, they must meet additional criteria in order to qualify as the company type concerned.

Note also that you can register one of these types of company via a paper application form only — i.e. you cannot register electronically.

Community Interest Company (CIC)

A CIC is a type of limited company designed for people who want to run a business for the benefit of the community — i.e. not purely for the benefit of the company’s members and shareholders.

A CIC may be a public or private company limited by:

• share capital
• guarantee with or without share capital

A company cannot become a CIC if it is:

• is a charity
• intends to be a political party, a political campaigning organisation, or a subsidiary of either

If you intend to set up a CIC, you must register it with Companies House. You can register either via a paper application form or electronically using a third party with access to the necessary software — eg an incorporation agent, software provider or solicitor.

However, it’s the CIC Regulator that decides whether or not your company is eligible to become a CIC.

To be accepted, you must pass a ‘community interest test’ and ‘asset lock’. These ensure that the:

• CIC is established for community purposes
• assets and profits are dedicated to these purposes

CICs are often seen as a type of social enterprises and may take the form of:

• leisure centres
• housing associations
• worker-owned co-operatives
• community development trusts

Right-to-manage (RTM) company

An RTM company is run by leaseholders who have taken on the landlord’s management functions, eg repairs and maintenance of the premises.

For a company to be an RTM company in relation to those premises:

• it must be a private company limited by guarantee
• its articles of association must state that its object, or one of its objects, is gaining the right to manage those premises

Societas Europaea (SE)

An SE is a trans-European company that may be created on registration in any European Economic Area state.

If you wish to create an SE in the UK, you must register it with Companies House.

An SE can be formed:

• by merger
• as a subsidiary
• as a holding company
• by a PLC transforming itself into an SE

If registered in the UK, an SE:

• is a public limited company (PLC) formed in accordance with the Companies Act 2006 and related legislation
• must have both its registered office and head office in the UK — although they don’t have to be at the same address

An SE must have share capital and shareholders whose liability is limited in a similar manner to that of a PLC.

An SE may denominate its share capital in any currency provided that at least £50,000 is denominated in sterling or €57,100 is denominated in euros.

It must also have a minimum amount of subscribed share capital equivalent to €120,000.

As a PLC, an SE registered in the UK must submit an annual return to, and file company accounts with, Companies House.

European Economic Interest Groupings

A European Economic Interest Grouping (EEIG) is an association of businesses and/or individuals from different European Union (EU) countries who need to operate together across national borders.

Its aim is to facilitate or develop the economic activities of its members but is a separate entity from their own businesses.

An EEIG may be set up in any one of the Member States, and operate in any part of the EU. It can also enter into arrangements with organisations outside the EU, although these organisations cannot themselves become members of an EEIG.

An EEIG must be registered in the EU Member State where it has its ‘official address’. The official address must be where either:

• the EEIG has its central administration
• one of its members has its central administration or — in the case of an individual who is a member — their principal activity, provided that the grouping carries on an activity there

You must register with Companies House if:

• it’s a new EEIG and its central administration is going to be in the UK
• you want to transfer an existing EEIG’s central administration to the UK
• you want to set up an establishment for an existing EEIG in the UK — even if its central administration will remain elsewhere in the EU

Registration with Companies House is via paper application only.

UK establishments of overseas companies

If you are an overseas company, you must — within one month of opening a UK establishment — register with Companies House. Registration is via paper application only.

If this is going to be your first UK establishment, you must also send Companies House:

• a certified copy of your company’s constitutional documents, eg charter, statute, memorandum and articles of association, with a certified translation in English if the original is in a language other than English
• a copy of your company’s latest set of accounts, again with a certified translation in English if the original is in a language other than English

You only have to submit the accounts if either:

• the accounts must be filed under the law of the country in which your company is incorporated — the ‘parent law’
• your company is incorporated in a European Economic Area state and the parent law requires you to prepare and disclose accounts but does not require such accounts to be audited or delivered

If this is going to be an additional UK establishment, you don’t have to deliver the constitutional documents. You may instead state in the registration document that you have delivered them in respect of another UK establishment — but you must give the registered number of that establishment.

You must notify Companies House of any changes to the original registration information. You must deliver the forms notifying the changes to Companies House within 21 days of the change.

If there is a change in the parent state that affects your company, you must deliver the notifying form to Companies House within 21 days of the date on which notice of the change could have been received by post in the UK.

Buying a franchise

A franchise is not a legal structure but is a business model that can operate under one of the legal structures, ie as a sole trader, or type of partnership or limited company.

Buying a franchise is a way of taking advantage of the success of an established business. As the ‘franchisee’, you buy a licence to use the name, products and services of the ‘franchisor’ business. This licence normally covers a particular geographical area and runs for a limited time, after which it should be renewable as long as you meet the terms of the franchise agreement.

Franchise agreements usually set out how the franchised business should be run, although they may allow some flexibility. Franchisors usually provide management help and training to franchisees.

The way you pay for the franchise may be through an initial fee, ongoing management fees, a percentage of your turnover, purchases of goods from the franchisor, or a combination of these.

You often pay a percentage of your turnover to the franchisor, which reduces your overall profits.

Thank you for reading.

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