When starting a business in the UK, you’ll need to consider the type of structure under which that business will be run, as this will have legal and tax implications. There are a number of options to choose from but, unless you understand all the pros and cons, and how each structure operates in practice, selecting the right one can be confusing.
Below we look at the legal structure of a business UK, identifying the four main types that can be used, together with each of their benefits and drawbacks, depending on your situation.
What are the main types of companies UK?
There are various ways in which you can establish and run a business in the UK. The different types of UK business structure are:
- Sole traders
- Partnerships
- Limited companies
- Limited liability partnerships
Ultimately, it’s for you to decide which structure will work best for your business, so its’ important to research each option, and consider the advantages and disadvantages of each.
Sole traders
Operating as a sole trader is the most common type of business structure in the UK. Sole traders start, own and run their business as an individual, making it the easiest business structure to set up and manage. You simply need to tell HMRC that you’re self-employed and register to pay tax through the self-assessment scheme. However, UK law doesn’t see sole traders as separate to their business. This means that they’re not treated as a distinct legal entity, but as one and the same, making the sole trader personally liable if their business goes into debt.
Partnership
Setting up a partnership is the simplest way for two or more people to run a business. Each partner will need to register for self-assessment, although a nominated partner must also file a partnership return. With the involvement of more than one owner, this makes the accounting responsibilities greater than when operating as a sole trader. Partners will also be held personally liable for any debts, where the partnerships’ finances will not be treated separately from the partners’ own finances, but the risks of running the business will be shared.
Limited company
Starting a company is the most complex type of legal structure, regardless of whether you’re going into business on your own or with anyone else, with extensive filing and reporting requirements in relation to both HMRC and Companies House. These include registering the company’s name and address, submitting a confirmation statement and company accounts, and filing a company tax return. This makes setting up and running a limited company far more costly and time-consuming than operating as either a sole trader or partner. As a limited company, your annual accounts and financial reports will also be placed in the public domain.
However, a company has a separate legal identity to its owners, meaning your personal assets will be protected in the event of company insolvency. Depending on the level of your profits, a limited company can also be the best structure when it comes to tax efficiency.
Limited liability partnership
A limited liability partnership (LLP) is essentially a hybrid form of business entity, between a partnership and a company. LLPs allow for a traditional partnership structure for two or more people, with similar tax treatment, but you’ll only stand to lose what you invest.
As with a limited company, the LLP model protects its members’ assets, limiting their liability to the amount of money they’ve put into the business and any personal guarantees given when raising loans. In this way, the LLP will provide you with a greater degree of protection from financial risk than the traditional partnership, but still allow you the flexibility of organising your internal structure in the same way. However, as with a limited company, you’ll be required to register the partnership with Companies House. Running an LLP also gives rise to certain filing and reporting obligations with Companies House and HMRC.
Considerations when setting up a company
With each type of business structure, there are various different legal, financial and practical considerations to take into account, where choosing the right one can be crucial to how you want to run your business and the level of risk that you — or and any other person, if going into business with someone else — is willing to take. This is because the structure you choose can have significant implications for all sorts of things, from the amount of tax you pay and the accounting responsibilities involved, but any personal liability should the business fail.
Starting out with the wrong set-up and structure can become disruptive and bring additional cost and inconvenience should you need to move to a different structure. You should therefore think carefully about which structure is best suited to your needs, depending on factors such as the nature and size of your business, whether you intend to do business on your own or as a joint venture, and your future plans for it.
The way in which you intend to do business will affect all sorts of matters, including:
- any authorities you need to notify that your business exists
- the records and accounts that you have to keep
- your financial liability if your business runs into trouble
- the ways in which your business can raise money
- the ways in which management decisions are made about the business
- the type of tax and National Insurance contributions that you have to pay
Setting up and running either a limited company or limited liability partnership can be both costly and complex. You’ll have specific registration requirements, with various other rules and responsibilities on an ongoing basis. However, if you’re looking to limit any personal liability, you’ll need to understand these rules, and be prepared to take on these extra responsibilities. If you’re looking for scalability, you’ll also need to think about one of the more complex structures to allow for business growth moving forward.
Securing expert advice from the outset can be crucial to making the right decision, both in relation to setting up a new business and the financial implications arising out of this.
Tax implications for different types of companies UK
The type of tax that a business will be liable to pay will depend on the legal structure used to run that business. There are different tax implications for each.
As either a sole trader or partner, you’ll be liable to pay both Income Tax and National Insurance on your business profits through self-assessment. Under a partnership, you’ll also be required to submit an annual partnership return with HMRC, although the partnership itself isn’t taxed, where each partner will need to register separately for self-assessment.
Even though operating as a sole trader or partnership will undoubtedly provide business owners with the simplest way of paying tax, with the least accounting responsibilities, one of the biggest advantages of operating as a limited company is that this can enable you to legitimately pay less personal tax. This is because limited company profits are subject to UK Corporation Tax, set at a slightly lower rate than that payable for Income Tax.
As a director, you’ll still be liable to pay Income Tax and National Insurance contributions on any salary you draw, although any salary will be deductible against company profits. You can also choose to pay yourself just a small salary, instead of drawing most of your income from the business in the form of dividends, on which you’ll not be liable to pay any National Insurance.
Again, securing expert advice here can make a significant difference to the amount of net profit that you’re able to extract out of the business, and to its overall financial success.
How to set up a limited company in the UK
A limited company is a privately-managed business, typically owned by its’ shareholders and run by its’ directors. To set up a company, you’ll need at least one director and one shareholder, although the same person can assume both roles.
A private company can also be limited by guarantee where, rather than the liability of each member being limited to the amount unpaid on their shares, liability is limited to the amount each member agrees to contribute to the company’s assets if it’s wound up.
To register as a limited company you’ll need to complete form IN01, pay an application fee and be incorporated with Companies House. Incorporation is the process by which a business registers as a limited company. As part of your application, you’ll need to provide a company name, a registered office, details of the company’s intended business activities and the proposed director(s), as well as the company secretary if it has one.
You’ll also need to provide certain documents, including:
- a memorandum of association: a legal statement signed by all initial shareholders or guarantors agreeing to form the company, and
- articles of association: a document which sets out the written rules about how the company is to be run, as agreed between the company directors and the shareholders/guarantors.
Every company is required to have articles, which are legally binding on both the company and all of its’ members. The articles will help to ensure that the company’s business runs as efficiently and smoothly as possible, and will set out how decisions are taken.
You can either determine your own articles or choose to adopt standard model articles set out in legislation. However, even though the provisions of model articles are suitable for most standard companies — and you don’t need to write your own memorandum of association if you register your company online, as this will be created automatically as part of your registration — the benefits of seeking expert advice when registering a company cannot be underestimated. With the right advice, tailored to your specific needs, you can ensure that the company operates in the way that you intended. Your professional advisor can also help you to navigate the ongoing rules and responsibilities of running a limited company.
Documentation to set up a partnership in the UK
Partnerships can be an ideal solution for some types of business, as this legal structure offers the simplicity and flexibility to work together with other people without the administrative burden of incorporating and running a company. However, even though no special paperwork is needed to form a traditional partnership, absent an agreement, the partners will be jointly and severally liable for any business debts and liabilities.
A partnership agreement is therefore always advisable, to set out the basis upon which the business should be run and, crucially, how any business profits and losses will be shared. In this way, responsibility for any liability and indemnity can be more fairly apportioned, for example, based on capital contributions, and percentage of ownership and profit share.
These can be complex agreements, containing various kinds of clauses to cover a range of potential eventualities, but can prove to be invaluable in regulating the partnership relationship and averting or resolving disputes.
Seeking expert advice here can also be crucial in ensuring that the partnership agreement clearly sets out how you want the business to operate, including the extent to which each partner will profit from its success or be responsible for any failings.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services - a Marketing & Content Agency for the Professional Services Sector.
