Sole trader, limited company or partnership? This article gives an overview of some of the different legal structures available to the small business owner and how to go about choosing the right legal structure for your business.

What legal structures can I choose?

When you start your own business, one of the first things you'll need to do is choose a legal structure. The type of legal structure you choose will impact on:

  • the amount of tax you pay
  • the amount of control you have over your business
  • the amount of paperwork you'll need to deal with
  • any profit your business makes
  • your responsibilities if your business makes a loss.

What are the three main types of legal structure?

There main types of business are: sole trader, limited company and business partnership. We take a look the different business legal structures you can choose for your business start up below. 

Sole trader

This is the most common and simplest form of business structure. This is where you trade on your own on a self-employed basis.

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Sole trader

There is no legal distinction between you and your business - you are considered the same entity.

You are in charge of all aspects of your business - you can keep all your business's profits after you have paid tax on them. You will also be personally responsible for any debts of the business.  

You will be liable to income tax on profits and be liable to class 4 and class 2 NIC (class 2 is to be abolished from 6 April 2018). You will need to file a self-assessment return every year. Once your takings exceed £85,000 per year (from 6 April 2017) you will need to register for VAT

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Limited company

Companies are owned by shareholders and run by directors. They can be limited (usually smaller where shareholders are selected) or public (where shares available for purchase on a stock exchange).

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Limited company

Most limited companies are limited by shares, meaning the shareholders' responsibilities for the company's financial liabilities are limited to the value of the shares that they own but haven't paid for.  The shareholders of the company will usually have limited liability for debt of the company i.e. they will not be responsible for the debt personally.

There is more administration in relation to a company - every year a limited company must put together statutory accounts and send an annual return to Companies House and a Company Tax Return to HMRC. A limited company must comply to statutory rules and disclose information to the public. 

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Partnership

A partnerships is made up of two or more individuals who run a business with a view to making a profit.

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Partnership

Partners in a partnership will pay tax on a self employed basis, and therefore pay tax and be liable to class 4 and class 2 national insurance (in the same way as a sole trader).

There will be a partnership agreement detailing the money invested by each partner and the terms of profit share etc and partnership accounts will be drawn up.

The partners have unlimited liability in the same way as for sole traders, i.e. they are responsible personally for the partnership debt.

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Why does the legal structure matter?

The way in which the business is formed has a great effect on:

  • the responsibilities of the owners
  • the way in which funds are extracted
  • the legal obligations for both the entity the individuals themselves
  • the reporting requirements.

 

How should I choose?

Choosing a legal structure will be dependent on the kind of business you have (or plan to have) and there are pros and cons with any business structure. 

It is recommended you speak to a professional accountant or tax advisor to ensure that you have the most appropriate legal structure to operate your business. 

Can I change to a different legal structure in the future?

Yes, as your business changes / grows, a revised structure may be appropriate or as your personal circumstances change.

It is strongly advised that you seek professional advice before changing your business structure as you will have to meet certain legal obligations. 

 

Next Steps

Self Assessment tax returns for sole traders

This page will give you an overview of the self-assessment process and your legal obligations as a self-employed individual.

Read more

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