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UNITED KINGDOM
JURISDICTION INFORMATION

HOW DOING BUSINESS IN UK

CHOOSING THE BEST OWNERSHIP STRUCTURE
FOR YOUR BUSINESS

 

1. SOLE TRADER (SELF-EMPLOYED)
You should think carefully about which structure suits your particular circumstances before making a decision. Choosing the wrong structure could expose you to unnecessary costs and risks, while failure to address certain practical issues may result in you falling out with your business partners or associates. Having said that, the status of sole trader suits many professions where starting up does not require major investment, and where a skill - such as carpentry, bricklaying or freelance services - is just as important as business acumen. It will not stop you from employing people when you start to get busy, but it will allow you to keep a tight grip on your business and to run it as you wish.

Today, there are several business entity options available for entrepreneurs. Like anything else, each of them has advantages and drawbacks:

SOLE TRADERS Vs LIMITED COMPANIES

(A) GENERAL ADVANTAGES OF UK PRIVATE LIMITED COMPANIES
1. Liability is, in the vast majority of cases, strictly limited to the investments made by the shareholders.
2. Company Officers are not personally liable for their actions unless there is a clear and serious breach of their fiduciary duty.
3. Limited companies often benefit from greater prestige than their sole proprietorship or partnership counterparts. The reason is because such an enterprise normally requires more planning and thus is deemed more credible.
4. Limited companies often benefit from significant tax advantages. In fact, many countries around the world give exclusive tax incentives to this type of entity.
5. The rights of shareholders are normally clearly defined and protected.
6. Corporate taxes only become payable after the end of the financial year. This means money that would otherwise be taxed on a monthly or quarterly basis, is available to earn further interest before the final payment of tax.
7. You need only appoint one Director and one Shareholder.
8. Directors can be corporate bodies or private individuals.
9. A Director can be of any nationality.
10. All companies must appoint a company Secretary who can be of any nationality.

Most people who start in business do so as sole traders. They work on their own. They alone receive the income and are liable for any debts. The financial costs of starting up are minimised by working alone from home. It can be a lonely life but, instead of colleagues, you have customers. Business people who work in the same town often join organisations such as the British Chambers of Commerce or networking groups such as Business Network International where they meet other people who are in a very similar situation to themselves. Talking your problems over with other people in business, provided that they are not competitors, can help.

Being a sole trader is the simplest way to get started in business (although not necessarily the best, you need to get professional advice before taking the plunge). Once you have informed the government agencies of your intentions to go self-employed, you can start trading right away (subject to any specific licences you might require in your line of work).

As a sole trader, you can quickly adapt to changes in your business with minimal bureaucratic changes required and you have complete control over your business and accounting affairs. However, a sole trader is also ultimately responsible for any liabilities should anything go wrong. It is worth spending time considering which set-up company format is best for you. As a sole trader, you will not need to notify Companies House, nor deal with any administrative or accounting requirements which are required of Limited Companies. If you start working for yourself, you must register with the Inland Revenue as self-employed, even if you already send in a tax return. There are some exceptions and special rules for particular industries, like the construction industry.

Essentially, your business income is counted alongside your existing personal income, so the accounting side of your business will be very straightforward. As the name suggests, you will be personally liable for any debts you incur in the running of your business which you wouldn't be under the Limited Company route. In terms of accounting, you will need to submit an annual self assessment form to the Inland Revenue and keep accurate and up-to-date records of all business transactions and accounts. You will also be pay income tax on all profits and pay national insurance contributions on those profits. Losses can be offset against tax on other income. In the April after your business starts, the Inland Revenue will send you a Self Assessment tax return to fill in. The Revenue will also use the return to assess any profit-related (Class 4) NI contributions you may need to pay.

Self-Employed people are also liable for Class 2 NI contributions (currently £2.05 per week). If your income from self-employment is low (below £4,215 in the tax year 2004-05), you may be able to apply for the Small Earnings Exception. Also, if you're already paying NI contributions in another job, you may be able to defer paying your Class 2 contributions until the end of the tax year.

Even though you will have registered as "self employed" when setting up, you won't automatically be VAT registered. You do not usually need to register for VAT until your turnover reaches a certain limit in any 12 months, or you expect it to do so. This limit - the 'VAT threshold' - is currently £61,000. Your annual turnover is normally the total amount of money coming into your business from the goods or services you sell.

(B) SELF-EMPLOYED ADVANTAGES
Easiest and least expensive form of ownership to organize
Flexibility - no requirement for registration or filing documents
Fewer statutory controls
Lower National Insurance costs
Tax payable is Income Tax paid in two instalments.
Profits can be withdrawn at any time without PAYE problems.

(C) SELF-EMPLOYED DISADVANTAGES
The sole trader is the business. On the death of the sole trader, the business effectively ceases
Unlimited liability: the sole trader is liable for all debts of the business
May be at a disadvantage in raising funds and are often limited to using funds from personal savings or consumer loans
Fewer State benefits and tax relieves are available
Weak structure
There are certain businesses that will not use Sole Traders, particularly if you are a contractor
Tax and National Insurance is deducted directly from your profits for the year and there is less scope for tax planning as with a Limited Company

Being a sole trader will suit a large number of small business people, however it is not always the best route which is why we suggest discussing your choices with an accountant or other adviser. The limited company route limits the personal liability of its directors if something goes wrong, whereas the sole trader is ultimately personally liable for any losses the business makes, of if you are forced into bankruptcy. In addition, in some areas of business, having a limited company setup will enhance prestige and provide a more professional appearance in certain industries.

Before you start trading you will have to decide under which structure you intend to trade. This will be dependent on the type of business you are running and how you intend to develop in the future.

2. PARTNERSHIPS
You could set up in business with a colleague or friend. Perhaps you each have different skills to bring to the enterprise. One may be a good sales person and negotiator while another has the ability to provide a service, like mending guitars, writing websites, compiling accounts, analysing markets or sculpting. When you go into business with someone else, this is usually known as a 'partnership'. Everyone might own an equal share or some may have a larger proportion of the business than others. In a partnership, you are liable for the debts of the business in proportion to how much of it is yours and your income may be of a similar proportion.

Unlike other business formats, partnerships (and sole traders) can start trading straight away, although certain types of businesses may need a licence to trade. If trading under a name other than that of the owners, must display names of owners and an address, for each, at which documents can be served. Behind sole-traders, a partnership is the second most popular type of business and is more commonly associated with professional services such as accountants, solicitors and doctors. It is also common in partnerships for each partner to specialise in a specific area of the business. For example, in an accountancy service, one partner may specialise in bookkeeping, another partner may specialise in financial advice, and so on…

You have to be aware that because any decisions and actions are dependent on the other partners agreeing, certain conflicts may arise from time to time. Such conflicts have led to partnerships failing and so it is important that some control can be maintained by compiling a 'partnership agreement' prior to starting the business. This agreement will be outlined later in the article.

TYPES OF PARTNERSHIPS

(A) THE GENERAL PARTNERSHIP
The General Partnership, which is the scenario outlined above and is subject to The Partnership Act, 1890. Full partnerships, as outlined above, have between two and twenty partners, but more commonly, the number of partners in a full partnership lies between two and four inclusive.

An arrangement in which two or more individuals or other persons (such as a company and an individual) conduct business as partners, whether officially or not.

In terms of asset protection, general partnerships can be even worse than sole proprietorships. Anything that one partner does affects all of the partners, because each partner of the general partnership is personally responsible for all obligations of the partnership deals. Thus, each general partner's exposure to risk is increased by a factor equal to the number of general partners in the business.

(B) THE LIMITED PARTNERSHIP
The Limited Partnership, which is subject to The Limited Partnership Act, 1907. Limited partnerships they are very rare today and account for less than 1% of all partnerships in the UK. A limited partnership is formed when one or more of the partners invest capital into the business but do not participate in running and managing the business. These partners therefore have limited liability as they can only lose the amount of money that they initially invested into the business.

A Limited Partnership (LP) is an association of one or more general partners together with one or more limited partners to conduct business for profit as co-owners. The most important feature of a LP is that the limited partner enjoys limited liability as long as s/he does not participate in the control of the partnership business. The general partners of the LP are the ones who are responsible for the obligations of the LP.

In a limited partnership, it is the general partner who remains liable for the debts and obligations of the entity. For larger risk exposure, a company (corporation) may be formed to serve as the general partner. A corporate general partner is protected from direct attack by a judgment creditor because the ultimate liability for the debts and obligations rests with the shareholders. By spreading share ownership, individual exposure is considerably reduced. Even without a corporate general partner, risk can be spread by distribution of limited partnership shares. If a judgment creditor obtains a charging order against one partner, the order goes to that partner's share in distributions from the partnership, and not to the entire business.

(C) THE LIMITED LIABILITY PARTNERSHIP (LLP)
An LLP is similar in some ways to a standard Partnership, except that the individual members have lower liabilities to any debts which may arise from running the business. There are more administrative duties involved compared to the Partnership business structure. In fact, an LLP is more similar to operating a Limited Company. In terms of liability, the Limited Liability Partnership is itself liable for debts run up in running the business, rather that the individual members of the LLP. As a result, LLP's are only recommended for profit running businesses.

An LLP may be formed by two or more persons (individuals or companies, and not necessarily UK resident) to carry-on a trade or business. To form an LLP, the partners have to file an incorporation document at Companies House. The owners and managers of an LLP are the same. The management structure and relationship between the partners are a matter for agreement between them and may be recorded in a separate LLP Agreement, similar to a Partnership Agreement.

LLP ADVANTAGES
No personal liability on a member for the LLP's debts and contracts
No joint and several liability for the negligence of any member
As a separate legal entity, LLP's may own property, sue, and be sued in LLP's name
Members' liability to contribute in a winding-up is limited to the amount they agree to contribute in the event of a winding-up as recorded in the LLP agreement.

LLP DISADVANTAGES
Disclosure: information (in particular accounts and an auditors' report) must be filed with the Registrar of Companies and becomes public
Money and property contributed to the LLP becomes owned by the partnership unless otherwise stated and the contributor is not entitled to its return except as stated in the partnership agreements
Regulation: auditing and filing requirements.

3. LIMITED COMPANIES
A third way to run a business is as a limited company. The business is registered with Companies House and is an entity of its own. There are more rules associated with running a business this way but there may be tax advantages. Those involved have shares in the business proportional to their involvement. A limited company is regarded in law as a separate legal personality, distinct from its shareholders. For this reason, if the company for any reason is unable to meet its liabilities, the shareholders will only be personally liable for the unpaid amount of their shares. If the shares are fully paid, then the shareholder cannot be asked to pay anything further.

It is therefore, strictly speaking, incorrect to say that a company has limited liability; it is the shareholders whose liability is limited - up to the unpaid amount of their shares. This situation must be contrasted with the personal liability of a sole trader or a partner in a partnership (with the exception of a partner with limited liability or in the case of a Limited Liability Partnership (LLP)). In these cases the sole trader or partner may be personally liable for any debts which the business is unable to meet. As noted above, there may be instances when personal liability cannot be limited. This situation usually affects directors who may be personally liable if they have acted fraudulently of negligently. In particular, you should be aware of the personal liability which can accrue to directors if their company trades whilst it is insolvent.

Whilst the limitation of liability can prove attractive, you should be aware that in certain cases, notably when dealing with banks or other financial organisations, personal guarantees may be requested from the directors, and/or shareholders. This may then negate this particular advantage.

The UK draws a distinction between employment income and self-employment income. Directors are taxed on the basis that they have employment income. But in some countries the dividing line would be drawn at a different point and directors who are not full-time officers may be treated as independent contractors (that is, as if they were self-employed). All businesses have to comply with certain legal requirements. This can include requirements in relation to health and safety, Trade Descriptions Act, Data Protection Act and Employment Law, to name but a few.

As well as being a legal requirement, good health and safety practices pay for themselves by improving your reputation with customers, the local community and most importantly your own employees. If you employ five or more people, you are required to prepare a statement of policy on health and safety at work and to make arrangements to put this policy into practice.

UK FORMS OF LEGAL ENTITIES
STUDY COMPARISON

SELF EMPLOYMENT Vs LIMITED COMPANY
As many know, employees have rights on how many hours a week they must work on average. Most employees do not work more than forty-eight hours a week and receive overtime pay for additional hours put in. When self-employed, however, these rules do not apply. A self-employed person could work seventy hours a week, if that is what is needed, and would get paid no overtime or nothing else additional. Because they work for themselves, their wages depend on what they bring in.

Another responsibility that is given to the self-employed is taxing their income. A self-employed person must allot for his or her own tax payments and follow the guidelines set by the government. Normal employees depend on their employers to do this task for them and are not required to worry about this.

(A) SELF EMPLOYMENT Vs LIMITED COMPANY
ADVANTAGES AND DISADVANTAGES

Well there are pros and cons to each. A Limited company means you will have to have all your accounts audited by an accountant which will cost you around £500.00. However there are substantial tax benefits from being a Limited company as you can save on paying National Insurance Class 4 contributions.

Some examples:
If you earn £20,000 as a LTD company you will pay £2,898 total tax, self employed you will pay £1,435 more of a total of £4,334.
If you earn £30,000 as a LTD company you will pay £4,798 total tax, self employed you will pay £2,535 more of a total of £7,334.
If you earn £40,000.00 as a Ltd company you will pay £6,698.45 total tax, self employed you will pay £3,749 more of a total of £10,448.

Above £40,000 you will look to save around £4,000-£5,000 more.

Being a LTD company also protects your personal assets should you business get into financial difficulty. If you're starting out a capital is restricted and you expect to earn under £20,000 then it may worth sticking to being self employed and then move over to being a Ltd company when have more money available to you.

Typically self employed people get a bad deal with getting competitive mortgages. The reasons why are obvious; to the lender they are a risk, an unknown quantity. They could earn £100,000 one year, but only £10,000 the next year, so it's clear why lenders are cautious.

Traditionally self employed people had to go for self certified mortgages which means you need no proof of income. It may sound ideal but the rates are much less competitive, usually 1% to 4% above normal mortgages which is quite costly.

Over the last few years with more and more people working on casual contracts and freelance work lenders are becoming more flexible. If you can prove your income over the last three years then you stand a very good chance. Proof will need to be provided by a certified, or better yet a chartered accountant. Many lenders will accept your tax SA302 form which show your income declared to the tax office. For those with less than 2 years proof may find it difficult to get anything other than a self-certified mortgage. If you are self-employed and your partner is on fixed income then this will make your chances of securing a competitive mortgage much improved.

All businesses have to comply with certain legal requirements. This can include requirements in relation to health and safety, Trade Descriptions Act, Data Protection Act and Employment Law, to name but a few.

As well as being a legal requirement, good health and safety practices pay for themselves by improving your reputation with customers, the local community and most importantly your own employees. If you employ five or more people, you are required to prepare a statement of policy on health and safety at work and to make arrangements to put this policy into practice.

(B) LIMITED COMPANY Vs PARTNERSHIP
ADVANTAGES AND DISADVANTAGES

Should you operate as a limited company or partnership? Or perhaps go for limited liability partnership (LLP) status, which some believe offers the best of both worlds? It is essential to select the appropriate status for your business, as this will determine a number of other issues including tax, future succession of the business and many other factors.

Whilst it is frequently assumed that incorporation brings substantial tax benefits and greater financial protection to directors, this is not always the case. In fact, for some businesses, running as a partnership can be the most efficient and rewarding route.

Each firm must assess its particular ambitions in view of current circumstances and decide the most appropriate route. Indeed, selecting the best operating vehicle for your organisation is just one part of business planning, but first, let's recap on some basic differences between limited companies and partnerships.

A limited company is a legal entity, run by directors and owned by shareholders, who are frequently the same people. Each company must publish its annual accounts, although small organisations need only provide a basic financial summary and for those with turnover under £5.6 million per annum, no audit is required.

In contrast, partnerships are owned and run by individual partners who are personally and jointly responsible for the actions of their fellow partners which partly accounts for the importance of a partnership agreement or deed.

Partnerships do not have to publish or audit their accounts, however large they get, although there is a move towards increased transparency.

A few of our clients have set up a limited liability company to run alongside the partnership to which different types of projects are directed. This affords maximum flexibility and helps the business to protect itself. It can also be a useful means to ensure succession as partners leaving a partnership can result in dissolution whereas a company continues, even when directors retire or leave.

Limited liability partnership, which became available from 6 April 2001, brings the benefits of limited liability whilst maintaining a traditional partnership. Not surprisingly, an increasing number of businesses of all sizes are considering this.

As the members have limited liability, the protection of those dealing with an LLP requires that the LLP maintains accounting records, prepares and delivers audited annual accounts to the registrar of companies, and submits an annual return in a similar manner to companies. The exemptions (and limits) available to companies with respect to delivering abbreviated accounts and exemption from audit also apply to LLP's.

Do you need to limit liability?
The type of work you undertake or your client portfolio often dictates whether or not limited liability is required. Typically, if you have regular overseas projects or work for quite large clients, incorporation may be appropriate from a commercial point of view.

But limited liability does not protect the proprietors entirely; for instance personal guarantees may be required if loans or other finance are required. In any event, insurance should always be considered to cover potential liabilities.

How much do you want to take out of the business?
Broadly speaking, if you plan to leave or re-invest money in the business, incorporation can offer advantages as profits left in a company attract corporation tax at lower rates than income tax. The highest corporation tax rate of 30% is only paid on profits exceeding £1,500,000. In contrast, partners pay income tax of up to 40% on the whole of their profits whether or not they draw all those profits.

Whilst income tax rates for partners and directors are the same, directors of a limited company pay national insurance contributions (NIC’s) at a much higher rate than members of a partnership which adds significantly to both the company's and individual's tax bill. Indeed, to pay the director of a company and member of a partnership £65,030 net, the company would have to make 14.3% more profit than the equivalent partnership. Indeed, in the example below, the limited company pays a total of £49,272 to the Government, whilst the partnership pays £34,970.

 

Limited Company

Partnership

Profits

114,301

100,000

Director's remuneration

(101,331)

 

Employer's NIC

(12,970)

 

Retained profits

Nil

 

 

Directors/partners gross income

101,331

100,000

Income tax

(32,491)

(31,959)

Employee's/parners contributions

(3,810)

(3,011)

Net income

65,030

65,030

However, if directors take a lower salary and reinvest more in the firm, limited liability may offer financial advantages. In short, different levels of profitability create a different financial picture and any decision regarding structure requires careful consideration of your current and future objectives.

Many companies also enjoy substantial flexibility to structure an efficient reward package, largely because the roles of shareholders and directors are blurred in owner-managed businesses. Profits can therefore be extracted through a mix of salary, bonuses, pensions, dividends and other benefits to create a tax efficient package.

However, a dangerous precedent for companies arises where husband and wife shareholdings exist. As a result of this case, HM Revenue & Customs (HMRC) can challenge dividends paid to the spouse who is not actively involved in the business and seek to assess that spouse's income as part of the other spouse's income, and crystallise a higher rate liability.

HMRC can challenge dividends paid to the spouse who is not actively involved in the business. HMRC can then, in turn, seek to assess the less active spouse's income as part of the other spouse's income, which could lead to a higher tax charge.

Who should own the business?
Traditionally share ownership was seen as providing flexibility to owners of a company. For example, ownership can be extended to spouses and children, who can often be paid very efficiently in dividends (depending on the individual's other income). Additionally, owners of a company can promote senior staff to director level providing a useful incentive without having to devolve ownership of the business. Planning opportunities are limited in this context.

Shares can also be used as a means to reward and incentivise staff, particularly if you set up a share scheme such as the Enterprise Management Incentive scheme. This scheme has been recently extended and represents a particularly good deal for employers and employees alike.

Spreading ownership is more difficult in a partnership, although a practice can appoint 'salaried partners' (who may adopt some of the responsibilities of partnership but continue to be paid under PAYE) as well as 'equity partners'. This really is a halfway stage and most salaried partners would expect equity partnership in due course.

SUMMARY
In short, there are potential tax savings available to both partnerships and companies. Deciding the best route for your business is likely to depend on your current level of profitability, investment needs and goals.

 

Partnership

LLP

Limited Company

Limited liability

No

Yes unless negligent

Yes unless negligent

Laws and statutes

Partnership Act1890 - 50 sections

Limited Liability Partnership Act 2000 and LLP Regulations 2001. Legislation based on Companies Act etc - 76 pages of regulations

Companies Acts 1985 and 1989 - over 900 sections and schedules. Insolvency Act 1986 - over 450 sections and schedules

Audit requirement

No

Yes - Subject to exemption limits

Yes - Subject to exemption limits

Disclosure of information

None

LLP Regulations 2001 and GAAP. Certain provisions of the Companies Act.

In accordance with Companies Acts and GAAP

Remuneration

Profits/drawings

Profits/drawings

Salary/dividends

Taxation

Income tax

Income tax

Income tax, NIC and corporation tax

Ownership

Partners

Partners

Shareholders

Management

Partners

Partners

Directors

Costs of changing

No additional costs

Legal costs in setting up. Audit costs

Legal costs of conversion. Audit costs. Additional tax costs

Aprroximate set up costs
Incorporation
Legal costs (members / partnership / shareholders agreements etc.)


N/A
£1,000+


£250
£1,000+


£250
£1,000+

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

 

 

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