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CATEGORY - SELF-EMPLOYMENT

YOUR CHOICE OF LEGAL ENTITY

One of the first decisions you will need to make is the legal form of your business. For most people this will boil down to being either a sole trader (or a partnership if there are other people involved) or a limited company. There are advantages and disadvantages to both.

A sole trader or partnership is indistinguishable from the people running it. The profits of the business are your income, but so are the debts. If your business cannot pay its bills, the creditors will look to you for payment instead.

A limited company confers a degree of protection from outstanding debts as the shareholders are only liable for the amount of capital they invest in shares. This can be as little as £1. In some ways the benefits of limited liability are a chimera because any serious lender will expect you to guarantee the debts of the company and even put up your own home as security. There is also such a thing as fraudulent trading whereby directors can be made liable for debts of the company if they knew at the time they were incurred that there was little or no prospect of them ever being paid. That apart, limited liability is a big advantage.

One of the disadvantages is the additional financial disclosure required of limited companies. Statutory accounts must be filed at Companies House each year and will be available for inspection by the public. However, most small companies only have to file abbreviated accounts consisting of a balance sheet and a few notes. No profit and loss account is required so you can still maintain a certain amount of privacy over your financial affairs. Only the Revenue will require a full set of accounts, plus an analysis of your expenses.

A limited company is a separate legal entity from its shareholders or directors so its income and assets do not actually belong to you. If you want to take money out of the company, you must declare it as salary, dividends or expenses. Alternatively you could take it as a loan but you would need to pay the company a certain rate of interest or it would be treated as a taxable benefit. The company would also have to pay extra corporation tax until such time as it was re-paid. Furthermore, if the company was unable to pay its bills as a result then the creditors could appoint a liquidator who would seek to recover the loan from you.

The other main advantage of trading as a limited company is the opportunity to reduce tax and NI contributions by taking profits as dividend rather than salary. This is the so-called tax-motivated incorporation so despised by the present Government. See our information sheet on Dividends for details of how this works. A husband and wife reach owning 50% of the shares in a company could save tax and NI of over £15,000 per year with the correct mix of salaries and dividends.

The above tax savings may appear too good to ignore but there may be some advantage to staying as a sole trader or partnership for the first few years and then incorporating as a limited company later. Profits in the early years may be too low to produce much of a tax saving by trading as a limited company, but it also gives you the opportunity to create some goodwill in the business, being its overall value in excess of the tangible net assets. You could then incorporate the business as a company, sell the assets to the company including the goodwill, treat it as a capital gain qualifying for entrepreneurs relief and take the cash tax free from the company until the debt is re-paid. However, it must be said that the goodwill must attach to the business itself rather than its owners otherwise the Revenue would disallow it (were they ever to prove that this was actually the case!). See our information sheet on Incorporation for further details.

Finally, some advice about partnerships. When you go into partnership with other people you do not just agree to split the profits between you in a certain way. You also become responsible for any debts they may incur on behalf of the partnership. All partners are jointly and severally responsible for the debts of the partnership, so you need to trust your partners implicitly. Often people go into business together as partners when it is really just one or two of them who run the show and earn most of the fees. The other partners may play their part, often an important part, but you should consider whether they should really be partners or whether it would be more appropriate for them to be employees or external consultants. As employees you can still reward them with a stake in the business if you trade as a limited company as there are some good staff share schemes with tax advantages, but you should try to avoid a situation where the tail starts wagging the dog and the whole business falls apart because the partners no longer agree. The same thing goes for directors and shareholders in a limited company. Be careful who you go into business with!


Acumen Tax Solutions
2 Purley Bury Avenue, Purley Oaks, Surrey CR8 1JB
Tel: 020 8406 9425 Mobile: 07813 582890 E-mail: info@acumentaxsolutions.co.uk

For information of users: Although every care has been taken in compiling this material, it only provides an overview and does not take the place of an individual consultation. We strongly advise all users to consult the detailed legislation or seek professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or this firm.

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