Starting a new business? Have you fully considered your options?
If you are setting up a new business then one of the things you will need to consider before you start is your business structure.
There are two basic choices:
- Be self-employed, or
- Incorporate your business and trade as a limited company.
There is a world of difference between the two options.
Self-employed suggests that you work on your own as a sole trader and this is certainly one option but not always the best one.
You could have a business partner or partners and trade as self-employed but in a formal partnership arrangement.
Before you decide to take this route, you should be aware that there are two basic types of partnership:-
- A Limited Partnership (where the partners are not personally liable for any business debts)
- A standard or Non-Limited Partnership where the partners’ personal assets are at risk in the event that the business cannot pay its debts.
This personal liability aspect is one of the key aspects which need to be considered when deciding on a structure for your new business.
The other is the impact of National Insurance (NI) and Tax.
If you are self-employed and trading on your own as a sole trader or as a partnership, the profits of the business are taxable based on the tax status of the business owner or owners.
There is no flat rate applied to business profits as would be the case if your business was set up as a Limited Company in which case the profits would be subject to Corporation Tax.
So the more you earn, the more NI and Income Tax you will pay.
Once you hit the £50,000 mark any profits above that figure will be taxed at the higher rate of 40%. By way of comparison, the Corporation Tax rate which applied to profits from Limited Companies is currently 19%.
And don’t forget, if you are self-employed and you run into financial difficulties, your personal assets may be at risk – unless you have opted for the Limited Liability Partnership arrangement.
A Limited Company
Alternatively, you could set up a limited company that is treated as a legal entity in its own right. Companies pay Corporation Tax on their profits, not Income Tax, at a single rate, presently 19%.
At first sight it may seem like a no-brainer, why would you be self-employed and pay much higher rates of NI and Income Tax? Combine this with the limited liability aspect and the argument for trading as a Limited Company seems compelling.
Of course it’s not that simple as there are other matters to consider which could swing the argument the other way.
Any profits withdrawn from the company as salary will be subject to Tax and NI anyway and the costs of administering a Limited Company are usually higher.
The decision will often depend on how high the profits are likely to be and how much you, as the owner, will need to withdraw from it to live on.
Planning is key
Every potential new business-person should look at both options. There are pluses and minuses to each and both need to be considered.
At THP our team are continually being asked this question and have decades of experience in answering it!