What are the ways you can set up a business in the UK?
There are 3 main types of trading:
- Sole Trader – This is 1 person trading in business alone as self-employed
- Partnership – This is 2 or more people trading in business together
- Limited Company – Either a Sole Trader or a Partnership can decide to trade as a Limited Company.
What are the differences between a Partnership and a Limited Company?
The way the business is owned:
A Partnership is owned by the Partners. You can own different percentage levels, e.g. 50/50 or 70/30 etc. It is recommended that a Partnership agreement is drawn up stating the percentage of ownership per Partner as soon as a Partnership is agreed. A Partnership can be set up by informing HMRC.
A Limited Company has shares and each owner is called a Share Holder. Each Share Holder has a certain number of shares. A Limited Company must be created at Companies House as well as HMRC being informed.
The liability of each owner:
As a Partnership, there might be 2 or more Partners, but the business and the owners are seen as I entity in the eyes of the law. If the Partnership owes money to suppliers and can not pay that money through the business, the owners have to pay the suppliers through their own personal finances.
A Limited Company is seen as a separate entity to its Directors and Shareholders. This means if the company owes a supplier money, it is only the company that owes the money to the supplier and as long as the Directors have managed the company correctly, there would be no reason where a supplier could target the personal belongings of a Shareholder to clear a bill that is owed by the company.
How money can be taken out of the business by the owners:
As a Partnership, there is no protection for the individual Partners against business liability as mentioned above. Because of this Partners will take money out of the business as drawings. If the Partners took more money out than the available profit, there would be no tax implications on the Partners. If enough money is not left in the business to clear the business debts, the Partners themselves are personally liable to pay the debt.
A Limited Company means the Shareholders personal belongings are protected against debts of the business because there is Limited Liability. To offset this there is also much more legislation on how a Shareholder can take money out of the business. A Director/Shareholder can take a wage through the company using PAYE just like any other employee. After wage, any other money withdrawn must be covered by available profits after tax has been deducted. If the Director/Shareholder took out more money from the business than was available, this is called an overdrawn Directors Loan Account.
What happens if you take too much money out of a Limited Company so have an overdrawn Directors Loan Account?
- You have 9 months and 1 day to pay the overdrawn amount back to the company.
- If the overdrawn amount is not paid back in time you will need to pay tax on the overdrawn amount.
- HMRC will refund the tax once the overdrawn amount has been repaid to the company.
What are the differences in tax calculations between a Partnership and a Limited Company?
Partnership
Income Tax:
Each partner can earn an amount of income, tax- free. This amount is set every tax year.
Income Tax Rates:
Profit is taxed at different percentage rates depending on the amount of income and the tax rates of the year.
National Insurance:
Each Partner must pay National Insurance on a level of profit depending on the year
Limited Company
Corporation Tax:
There is no tax-free income allowed in a Limited Company. We recommend running a Directors Wage which would then allow the Director/Shareholders to take out the maximum amount before Tax & NI is charged.
Corporation Tax Rates:
Profit is taxed at the percentage rate depending on the year, but the rates are not the same as income tax rates.
Dividend Tax:
There is no National Insurance to pay but there is Dividend Tax to pay
What are your next steps?
It is important to consider:
What is more important to you, flexibility over drawing money, or protection over personal assets? Flexibility over drawings means you would be more suited to being a Partnership. Protection over personal assets means you are more suited to setting up as a Limited Company.
What are your future goals for the business? Share this with us and we can help you decide your best options.
At what income level will it be more tax- efficient to go from a Partnership to a Limited Company? We can help with calculations that will help guide your decision.
Share your goals with us and we will:
Explain your options further, complete any calculations to show when tax efficiency kicks in, and help light the way for your next steps.