Which structure should you use for your business?
Sole Trader or Limited Company?
When you are self-employed you are classed as a Sole Trader. This is the simplest structure for your business. A Limited Company is a more formal business structure. It’s not just the tax implications that should be considered, there are other factors that should assist in your decision as to which structure to choose for your business. Here are the main differences between the two.
- No distinction – you are your business
- All the debts relating to your business are your debts
- If the assets of the business do not cover the debts your personal assets could be used to pay the debts – including your house
- No need for a separate bank account (but is recommended for good practice – can be a personal account)
- You rely on your own personal credit rating to borrow money
- Less paperwork = lower accountancy fees
- Generally assumed to be a ‘one-man band’/less credible
- More flexibility
- Losses can be set off against employment income to reduce tax paid
- When working from home can claim more household expenses
- The company is a separate legal entity
- The debts of the company belong to the company
- Personal assets are not used, except in cases where a personal guarantee has been given
- Your personal loss is limited to the amount you invested in the company
- You need a separate business bank account
- Company can establish its own credit rating against which to borrow money
- More paperwork = higher accountancy fees
- Seen as more credible
- Losses can only be offset against previous/future profits of the company
- Less expenses can be claimed when working from home
Partnership or Limited Liability Partnership (LLP)?
If there are two, or more, of you going into business together it is worth considering whether to structure your business as a traditional partnership, a limited liability partnership (LLP) or as a limited company with you all being directors.
A traditional partnership is an extension of being a sole trader. The partners are taxed in the same way as a sole trader, but just for their share of the profits, and a return is also required for the partnership as a whole. As with sole traders, the partners are legally liable to pay the debts of the business, and each partner is ‘jointly and severally’ liable for the partnership debts.
An LLP is legally similar to the Limited Company, in all aspects apart from tax where it is treated like a traditional partnership.
Alternatively, you could set up a Limited Company with each person as a Director.
With any of these structures, you will need to agree the share of the profits beforehand. It is also recommended to get an official partnership agreement through a solicitor – even if (especially if) you are going into business with friends or family.
IR35 was introduced to stop people setting up and working through a limited company to avoid paying tax instead of working as a normal employee – you may have seen the term ‘disguised employee’ in this context. If the person carrying out the work is working on the same terms as an employee, then IR35 may be an issue. This is particularly significant in the Construction Industry, and for Limited Companies working solely for one customer. If this applies to you then you will need to speak to an accountant and a solicitor with IR35 knowledge to ensure you have a water tight IR35 contract in place before setting up a limited company.
In a construction company the CIS (Construction Industry Scheme) may be applicable to you. You may be a:
- contractor – where you use people (sub-contractors) to do work for you
- sub-contractor – where you do work for other people (contractors)
- both – where you do both; work for contractors and have sub-contractors working for you.
We will look at CIS in more detail later on.
It is worth talking through your options with an accountant before making your final decision. Most accountants will offer a free consultation for new businesses, so make the most of it and ask about anything you are unsure of.
Sole Trader & Partnership
You’ve decided to become a Sole Trader, what do you do next?
First of all, you will need to register with HMRC. The tax year runs from the 6th April one year to the 5th April the following year. You can register on the HMRC website here (https://online.hmrc.gov.uk/login). You will need to register by the 5th October following the tax year you start your business – for example if you start your business on the 1st July 2016 this is during the 16/17 tax year (6th April 2016 – 5th April 2017), and you therefore need to register by the 5th October 2017.
You will need to complete a tax return for each year you are in business. For ease, the simplest way is to set your business financial year to more or less coincide with the tax year – 1st April – 31st March (plus this then covers full months and if you are using any bookkeeping software you will see they only work on a full month basis). Therefore, your first return would cover from the date you start to the following 31st March – for example if you start on the 1st July 2016 then your first tax return will cover 1st July 2016 to 31st March 2017.
Tax returns need to be filed by the 31st October following the end of the tax year if you wish to file a paper return, or by the 31st January following the end of the tax year if filing using the HMRC gateway or other digital filing method (i.e. through an accountant). Therefore, if you start on the 1st July 2016, your return for the 16/17 tax year will need to be filed by the 31st October 2017 (paper copy) or 31st January 2018 (digital).
If you are also employed, you will also need to include your employment income and you will need your P60 (and P11D for any benefits) from your employer to complete your tax return. These should be given to you by:
- P60 – by the 31st May following the end of the tax year
- P11D – by the 6th June following the end of the tax year
Any tax due will need to be paid by the 31st January following the end of the tax year (2018 in our example).
Tax may seem quite complicated, but for most sole traders without any other income it is actually quite simple. Tax is based on your profits from your business each year. This is not necessarily the money you have actually paid yourself from the business.
Each year you will have a Personal Tax Allowance. Most people have the same code, which is standard and increases each year. This is the amount of income you are able to earn before you need to pay tax. If you don’t have the standard tax code HMRC will send you a coding notice to advise what your tax code is and how it has been calculated.
If you earn over the personal tax allowance you will pay tax, the rate depends on how much you earn. Current rates can be found here (http://www.chaccountancy.co.uk/rates-and-allowances.html) on my website.
National Insurance is calculated separately from tax. When you are self-employed you will also need to pay Class 2 and Class 4 National Insurance.
Class 2 National Insurance needs to be paid on profits over the Small Profits Threshold. It is calculated using a weekly amount.
Class 4 National Insurance is based on a percentage of your profits over the Lower and Upper Limits.
Both are calculated as part of your tax return. There are currently talks to merge the two, so this could change in the future. HMRC will announce the changes in plenty of time before they actually happen, and your accountant if you have one will also keep you updated on changes.
Here is an example of a basic calculation, using 2016/17 rates and allowances:
Self-employment profit = £46,000
Less Personal Allowance of £11,000 leaves £35,000 taxable profit.
£31,786 (Basic Rate Band) @ 20% £6,357.20
£3,214 (remaining amount at Higher Rate Band) @ 40% £1,285.60
Tax Due £7,642.80
Class 2 National Insurance (52 weeks x £2.80) £ 145.60
Class 4 National Insurance
(£46,000 – £8,060 = £37,940 x 9%) £3,414.60
Amount Due to HMRC £11,203.00
If the tax you owe is over £1,000 HMRC will ask for a Payment on Account for the following tax year too. There are two payments on account, each totaling half of the tax due for the previous year.
Therefore, when you complete your return you'll be asked to pay the tax owed for the year on the return, plus the first payment on account for the following year (also due by the 31st January). You will then need to pay the remaining payment on account by the 31st July.
If when you do your next tax return, there is any extra owed this will be due by the following 31st January along with your tax return - this is called the balancing payment.
Using the previous example for the 16/17 tax year where there was £11,203 owed to HMRC for the year the following payments would be required:
By 31st January 2017
Tax & NI due for the year £11,203.00
1st Payment on Account for 17/18 tax year £ 5,601.50
Total Amount Due £16,804.50
2nd Payment on Account for 17/18 tax year due by 31st July 2018 £5,601.50
Any additional amount for 17/18 will be due by the 31st January 2019, along with the 1st payment on account for the 18/19 tax year.
If when you do your next tax return, there is less tax to be paid you can either reduce your 2nd payment on account if the return is filed by the 31st July, or you can request a refund, or put toward the next year's tax due.
TOP TIP - put some money aside each month to save for your tax bill – depending on your profit levels around 15-23% of your income should be sufficient (please check with an accountant for profits over £40,000 per year).
TOP TIP – get your return done as early as you can – trust me it’s a great idea!
If you have until the 31st January to complete and file your return, why should you do it early? Simply because there are benefits to getting it done early:
- it's out of the way, meaning less stress
- everything is still fresh in your mind
- if you're due a rebate you will get it earlier
- you could reduce your second payment on account
- you don't need to make the payment until the 31st January so it gives you plenty of time to save if needed or budget accordingly
- plenty of time to sort out any logging on/UTR/password queries
Have a read of my blog on getting your tax return done early here (http://www.chaccountancy.co.uk/news/article/tax-returns---time-to-get-your-rebate.html).
You don’t have to have separate bank account, but it is best practice. It doesn’t have to be a business account, you can use a personal current account (although check your banks terms and condition as some banks don’t like it!).
There are two ways of preparing your business accounts – cash or accruals accounting. When preparing your tax return HMRC will ask which method you are using. The main differences are as follows:
- Based on the money physically received and paid
- No need to raise invoices, but must be able to prove your sales i.e. with a receipt book
- Focuses on when services/sales & purchases took place rather than when paid
- Invoices are required to show when the work took place
- Most common type of accounting
If you are part of a partnership, then you will need to register the partnership as well as each partner separately. There will need to be a return for the partnership as a whole, then each partner will file their own return declaring their share of the profits, plus any other personal income.
When you are a sole trader, any money that you pay yourself from the business will be classed as drawings. These drawings, along with National Insurance payments, are not tax deductible and should be excluded from any accounts you prepare.
I am often asked ‘How much can I pay myself?” and here is a great guide from Xero to help with the answer https://www.xero.com/small-business-guides/business-management/pay-yourself/
This guide is more geared to limited companies, so some of the advice may not apply, but it is a good guide and the general principles are the same.
You’ve decided to set up as a Limited Company – now what?
First of all, check your potential company name on the Companies House website (https://beta.companieshouse.gov.uk). You are not able to use an existing company name, so you’ll need to make sure it is a unique name.
What if your chosen name is existing but dissolved? This is a risky choice as unpaid creditors from a previous company could think the company has re-opened and will expect you to pay their unpaid bills. It is advisable to choose something unique that hasn’t been used before.
Once you’ve decided on a company name you will need to register your company with Companies House and HMRC. This is also known as Incorporation. You can use an accountant to register your company (who will probably charge a small fee) or you can do it yourself via the Companies House website (https://www.gov.uk/register-a-company-online). Companies House charge a small fee when incorporating your company. Once registered with Companies House there will also be a link to register with HMRC for Corporation Tax.
When you register your company you will need to have a registered address. If using an accountant, this is usually your accountant’s address (many sole directors working from home often prefer this option), but it can be your main business address.
When you set up a limited company you will be a shareholder of your company (you will own the shares of the company, either on your own or jointly with others). You will also be appointed as a Director. If it is just you, you will be known as a Sole Director. As a director, it is your responsibility to ensure everything is done on time and correctly.
What needs to be done and when?
- Your accounts are due 9 months after year end and need to be filed with Companies House.
- You will need to pay Corporation Tax to HMRC on the profits of the company. The Corporation Tax Return (CT600) along with your accounts and a tax computation, is due 12 months after year end, but paid 9 months and 1 day after year end (yes you did read that right – you need to pay before the return is filed! In practice, the return is usually filed within 9 months along with your accounts being filed to Companies House).
- An Annual Return (AR01) is filed each year, usually on anniversary of incorporation due within 28 days of return date, you can check this on Companies House website (https://beta.companieshouse.gov.uk). This confirms the shareholdings, registered address, and other important company information. This does not include any financial information.
Corporation Tax is based on a 12-month period. The first ‘year’ is normally just over 12 months, as it starts on the date of incorporation and therefore will be split into 2 returns - the first 12 months then a small remaining period to the end of your financial year. From year 2 onwards each return will only cover the year, unless you change your financial year (always consult an accountant before changing your financial year).
When you set up a limited company you will usually be employed by your company. Therefore, paying yourself out of your limited company can be a mixture of salary and dividends. You may have heard the phrase ‘low salary high dividends’. This basically means paying yourself a low salary and the rest of your income will come in the form of dividends.
If you are a sole director with no staff then your salary will be set at the National Insurance limit, so you do not pay any tax or national insurance from your salary. If you have staff or there are 2 or more directors, then your salary will be your personal allowance for the year. This is due to the Employment Allowance. The government currently give each company a discount each year off of the Employers National Insurance contributions. This is only available for employers where there are 2 or more employees paid over a certain amount. Basically this means you will need to pay a small amount in Employees National Insurance out of your salary, but this is offset by the Corporation and Personal Tax saved.
Dividends are payable out of the profits after corporation tax. Dividends are treated as income rather than earnings, so there is no National Insurance to pay on dividends. There is a personal tax free allowance for dividends each year, and any dividends paid over this allowance are personally taxed at the dividend rates.
You may have heard of the term ‘Directors Loan Account’ or ‘Directors Current Account’. These are used to keep a record of money invested by or paid to the director. At the end of the year the balance of this account is what is owed to or owed by the director. If there are enough profits in the company dividends can be used to clear any balances owed by the director. If there isn’t enough profit, then the amount will need to be repaid by the director within 9 months to avoid any tax penalties. Any money owed to the director can be repaid to the director (when there is enough cash in the company available) without any tax implications.
I am often asked ‘How much can I pay myself?” and here is a great guide from Xero to help with the answer https://www.xero.com/small-business-guides/business-management/pay-yourself/.
An accountant can advise further on the most tax efficient method of paying yourself from your company, and this advice will then be tailored to your specific circumstances.
Directors will need to complete and file a self-assessment each year and pay any tax liability by the 31st January following the end of the tax year.
Limited companies are required to include your company name on all business communications (paper and electronic). It is also compulsory to have your registration details on letters, order forms and websites – this includes your registration number, which part of the UK in which your company is registered and your registered address.
Here are some useful links:
News & updates from CH Accountancy & Bookkeeping Ltd - http://www.chaccountancy.co.uk/news.html
Current Rates and Allowances http://www.chaccountancy.co.uk/rates-and-allowances.html
Sign up to my newsletter http://chaccountancy.us9.list-manage1.com/subscribe?u=73c038f899e4a7a8e00d1db1d&id=f6092e6636
Companies House https://www.gov.uk/government/organisations/companies-house
The Pension Regulator http://www.thepensionsregulator.gov.uk
DISCLAIMER – the advice within this e-Book is generalised. Please seek an accountant for specific advice relating to you and your business.