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| Do I Start A Limited Company Or Not? |
Do I Start A Limited Company Or Not?
Article by John Saxon CInst SMM
Would it be better for you to be self-employed, or to be a director of a limited company? What difference does it make? Each legal entity has advantages and disadvantages.
Here we have set out some of the obligations and liabilities, pros and cons associated with each option.
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| 1. Sole Trader (Self-Employed) |
This is a business owned by one person. Legally, the person and the business are one and the same. All financial risks are taken by that person and all that person's assets are included in that risk.
Obligations
- Keeping Records
If you are self-employed, you need to keep careful records. You must define personal transactions (e.g taking stuff from your own stock), and if you are working from home you must be careful about apportioning what is for business and what is for private use (e.g utilities bills.)
If you use a car for work purposes it is a good idea to keep a log-book, detailing business and private use of that car. You will find these records useful when you are filling in your tax return. (If you are working from home, you also need to think carefully about insurance, and Council Tax).
- Tax and National Insurance
When you first set up the business you must inform Inland Revenue that you are self-employed. You can find more information about how to do this, including a form you can use to notify Inland Revenue about your business, in Leaflet P/SE/1 "Thinking of Starting a Business?" You will also need to fill in a Self Assessment Tax Return.
The latest submission date for tax returns is 31st of January. There are financial penalties for late submission.
If you take on staff, you will have the additional responsibility of deducting Income Tax and Class 1 National Insurance Contributions from their pay, and paying it along with your Employer's Contribution to Inland Revenue, under the Pay As You Earn scheme.
- Liabilities
As a sole trader you are totally liable for any debts or legal compensation your business becomes liable for. Make sure you have adequate insurance. Without insurance you could lose everything.
- National Insurance
Class 2 NICs: These contributions are payable at a fixed weekly rate unless you have an exemption certificate. You can choose to pay these monthly by Direct Debit.
Class 2 NIC Rates 2000-2001 are a flat rate of: £2.00 per week
Class 4 NICs: These contributions are payable on profits between the Lower Profit Limit and the Upper Profit Limit. They are collected when you send in your self-assessment returns.
Class 4 NIC Rates 2000-2001 are based on 7% of profits between the limits.
Lower Profit Limit £4,385 Upper Profit Limit £27,820
Class 1 NICs: If you have staff you have the additional liability of Class 1 National Insurance Contributions which include the Employer's Contribution.
It is a very good idea to put money aside every month, to pay these contributions.
The pros...
If you are operating as a sole trader you have almost complete control over how the business is run. You can make decisions (as long as they are legal!) without interference.
The administrative costs of running a sole business are small. You will need to keep records for Inland Revenue (and also for VAT if you are VAT registered), but there are no other legal requirements.
...and the cons:
All your personal assets are at risk if the business fails. Personal bankruptcy can occur!
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* Tip
If you are thinking about setting up your own business and you are likely to be working as a contractor for larger companies, you need to be aware of Inland Revenue's legislation known as IR35.
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| 2. Partnership (Self-Employed) |
A partnership is a business run by two or more people together. There should be a written agreement detailing this arrangement. Profits are usually shared between partners according to the agreement. Although profits may be shared unequally, liabilities which may arise are shared jointly. This is something that everyone involved should be very clear about. Even if you only own 1% of the business you will still be responsible for 100% of the liability.
A partnership is a very risky type of business to get involved in, just because of all the potential for conflict, and the financial effect conflict between partners would be likely to have on the business.
However, now the Limited Liability Partnerships Act has received Royal Approval and will become Law by the end of the year. There are a number of advantages to LLP including limiting liability (as with a Limited Company) and the tax advantages of a Partnership.
Obligations
Your obligations are the same as for a Sole Trader (see above.)
Liabilities
Your liabilities are the same as for a Sole Trader (see above.)
The Pros...
Often more money can be raised to start the business if more than one person is involved. You will need to keep records for Inland Revenue (and also for VAT if you are VAT registered), but there are no other legal requirements.
Each partner should submit a P/SE/1 and you are taxed as an individual. If you leave the partnership your tax liability will follow you (unlike in the past when the remaining partner had to pay it). The workload can be shared.
...and the Cons
All personal assets of each partner are at risk if the business fails. Personal bankruptcy can occur. Decisions are taken jointly.
The agreement may specify different levels of decision making for each partner. Either way a stalemate could easily arise, or the decision making process could be hampered, if a decision cannot be reached without the major shareholder present.
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| 3. Limited Company |
Unlike a Sole Trader or a Partnership, the Limited company is legally a separate entity in its own right. The directors and shareholders have limited liability.
When a limited company is created it will have an Authorised Shareholding which specifies the limit of a shareholders liability. If all shares have been issued then shareholders are not liable for any more debts that the company may accrue. This is definitely the most sensible option if capital is being put into the business by anyone who is not involved in running it (i.e. shareholders).
Obligations
- Accountability
You have to hold an Annual General Meeting (AGM) for all the shareholders, within 18 months of setting up the company, and at least every 15 months after that. These meetings must receive, and approve, Annual Reports from directors and auditors. These reports must include summaries of the accounts, names of the directors, details about the shareholders, and other information. At these meetings the shareholders must also elect directors and auditors.
You must also submit an Annual Return to the Companies Registration Office, summarising the information included in the Annual Reports. These details are displayed at Companies House, where they are available for public inspection.
- Staff
A limited company always has staff, because a director of a company is considered an employee of the company, and a limited company must have at least 1 director, and a company secretary.
- Tax and National Insurance
Because a limited company always has staff, it must always operate a PAYE scheme. This should be set up at the same time as the company's limited status.
If you are a director of a limited company, bear in mind that there is a different set of rules for the payment of Class 1 National Insurance Contributions by directors.
Correct payment of income tax and National Insurance is the responsibility of the company director/s. If you are a director you need to make yourself aware of the appropriate legislation, because you cannot plead ignorance.
- Liabilities
National Insurance Contributions
Class 1 NICs: You will have to pay the Employer's Contribution part of the Class 1 NICs for all employees.
- Corporation Tax
As a Limited Company, you will have to pay Corporation Tax on all profits.
The pros...
Limited liability can usually protect directors, who act in good faith, from legal actions brought against them.
...and the cons
There is considerably more administration involved in running a Limited Company than there is for a Partnership or Sole Trader.
As mentioned above, even with no other staff, the "owner" or director of the company is considered to be an employee of the company, therefore the more expensive Class 1 National Insurance Contributions must be paid.
You cannot keep your business affairs private. You have to hold an Annual General Meeting (AGM) for all the share holders. You must also submit an Annual Reports to the Companies Registration Office, along with a fee (currently £15.00).
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| Conclusion |
As a rule of thumb you are usually better off, from a Tax and NI point of view, to set up as a sole trader or partnership - however few partnerships outlast the business and people who you have known for years, as friends, often turn out to be terrible business partners.
The new Limited Partnership may be the answer to this when it finally becomes Law. Limited Liability (in a Limited Company) should be looked at closely when you are dealing with high incoming costs, such as computer sales or design and print, where the gain is a lot lower than the risk if a customer should default on payment.
However if you are selling mainly time, or a high profit item, consider the tax advantages of sole trader or partnership.
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