As part of your Business Plan you need to decide what sort of business structure you want to operate. In this article I will focus on the two main business structures:
The main advantage of being a sole trader is that you can commence trading almost straight away. You operate the business as an individual and are legally responsible for the business. You can employ staff by registering a payroll with HMRC and deducting PAYE and National Insurance.
You do not need to file a Confirmation Statement nor Accounts for ‘public view’ at Companies House, thus saving fees and costs. Penalties for instance are charged by Companies House for late filing of Accounts.
You will need though to file accounts with HMRC via a Self-Assessment Tax Return, but the accounts are not available in the ‘public domain’.
You are taxed on your profits on an annual basis as the business owner and you are not an employee of your business.
Business expenses ‘incurred wholly, exclusively and necessarily in the course of your business’ can be deducted as a business expense. This would include a percentage of your ‘home costs’ if you worked from home. Please check restrictions though for trading from home, particularly in rented homes.
Class 4 National Insurance is charged in 2018/19 at 9% on your business profits between £8,424 and £46,350 with a further charge of 2% over £46,350. Class 2 National Insurance of £2.95 per week is also charged if your profits are above £6,205 (2018/19).
In terms of liability, you are ‘financially exposed’ as a sole trader and you are personally liable for the losses of the business. The business could make you bankrupt.
A loss incurred in the first four tax years of a trade may be carried back and set against the general income of the individual for the three previous tax years, using the earliest years first. This means that you could obtain a PAYE refund for instance from a previous year.
Proper accounting records are required, and are now a legal requirement if your turnover meets the VAT threshold of £85,000 (2018/19) and you will need to file VAT Returns under Making Tax Digital (MTD).
You can create a personal bank account to run the business, with payments being made to you personally thus saving business account bank charges.
Unlike a sole trader the business is a separate legal entity of which you are a Director and shareholder. The name of the business can be registered at Companies House as a Limited Company with yourself a shareholder. You can do the registration directly with Companies House to avoid the cost of a business specialising in company formation.
Business finances are completely separate from your personal finances and you will need to operate a business bank account.
Just like a sole trader, you can employ staff by operating a payroll, and as a Director you will be treated as an employee.
A Limited Company will pay Corporation Tax on its profits – currently 19% and one of the lowest around!
The Company is liable for any losses of the business rather than you personally!
You will need to file an Annual Confirmation Statement and Accounts with Companies House. Late filing of accounts will incur penalties that are rigidly applied. Accounts for instance need to be filed nine months after the year end.
You can be remunerated via a salary to cover your personal allowance – £11,850 in 2018/19 and normally a dividend (2018/19 – first £2.5k tax free and then 7.5% up to the basic rate of tax for 2018/19 – £34,500, and 32.5% at the higher rate band).
The Company is run by the Director/Directors but governed in law by the Memorandum and Articles of Association. Companies House will provide these to you on formation of the Company, and they can be amended by Resolutions.
Proper accounting records are required as per a sole trader above, particularly in light of Making Tax Digital (‘MTD’).
Choosing a Business Structure
Sometimes it is best to ‘test’ the business by first operating as a sole trader and then transferring to a Limited Company at a later date. And remember, you can utilise the tax losses as a sole trader in the first four years and then carrying those losses back up to three years. You cannot do this as a Limited Company, as the losses are carried forward within the Company.
Get your tax affairs in order pre-release
Remember to contact The Tax Academy CIC to review your tax affairs to ensure they are up-to-date. There is nothing worse than being released from prison, then finding out that you have tax penalties and tax debt that need to be resolved with HMRC.
Those of you in the construction industry in particular may be entitled to significant refunds.