The simplest way to set up a new business is to trade as a sole trader. This is ideal for a small business where the work is largely carried out by the proprietor of the business. There is no need to inform Companies House of the new business, thereby avoiding some of the more stringent rules that apply to limited companies. However, some of the tax benefits available to limited companies do not apply to sole traders.
Unlike limited companies, a sole trader is personally liable for debts incurred whilst trading, and ultimately could be made bankrupt should the business fail. A sole trader can run a small business and still be employed elsewhere but should seek advice as to their position with regard to tax and National Insurance Contributions (NIC) liabilities.
Class 2 National Insurance Contributions (NICs) must be paid, and income Tax will be paid at the personal Income Tax rate (traditionally 20% to 41% depending on taxable income, but from April 2010, a 50% rate is imposed on taxable income over GBP150,000) . Corporation Tax is currently between 21% and 28% for company taxable profits up to GBP1.5m turnover, but from April 2011, the rate for small companies will drop to 20%. The 28% higher rate for larger companies will also drop one percentage point to 27% in April 2011, with further annual incremental cuts announced by the government, designed to eventually bring the rate down to 24% by 2014.
Partnerships
A partnership is where two or more people share (equally or as specified in a partnership agreement) the costs and responsibilities of setting up in business. Partners are usually self-employed and each takes a share of the profits, and is taxed on their share accordingly; it is advisable to ask a solicitor to draw up a simple partnership agreement.
In the event of the resignation, death or bankruptcy of a partner, the partnership must be dissolved. Partners are personally liable for debts incurred by the business partnership and their personal assets may be at risk from creditors, even though other partners of the business might have incurred the debts.
Another form of partnership is a Limited Liability Partnership (LLP). With this form of partnership (which must comprise at least two members), there is limited personal liability for individual partners, but there is a general partner with wider responsibility. As with an ordinary partnership, partners are responsible for their own tax affairs and filing.
Limited companies
A limited company exists in its own right as a separate entity. Consequently, the finances of the company are distinct from the personal finances of the owners of the business. A limited company must be registered (incorporated) at Companies House. Limited companies must have at least one director and must appoint a qualified company secretary. A limited company can comprise as few as two directors, and only one or two employees.
Limited companies must inform HM Revenue and Customs of the existence of the company and that they are liable for Corporation Tax – an annual return must be submitted. Limited companies must also file accounts annually with Companies House and they usually have to be audited.
The type of limited company that is of interest individuals in business is limited by shares, and each member’s liability is limited to the amount unpaid on their shares. A private company cannot offer its shares to the general public for sale.
The terms 'Freelance', 'sole-trader' and 'self-employed'
A self-employed individual may variously be described in the UK as a freelance worker, sole trader, sole proprietor, self-employed, entrepreneur or similar term; regardless of how they are described or describe themselves, HMRC’s primary interest is in whether the individual is employed or self-employed for the purposes of liability to pay income tax and NICs, or whether they are employed, and will therefore have these deducted at source.
This has been a controversial area in recent years; the UK tax authority is keen to minimise ‘concealed employment’, and has put in place legislation to this effect, commonly referred to as ‘IR35’ legislation, although the Conservative-Liberal Democrat coalition has pledged to review the rules in this area.
This article is an extract from Personal Business Tax Guide , dated 4th January 2011, for the latest version please click here .