The Complex World of Business Structures Explained
January 10, 2019
Starting a business is an exciting time which may be the result of years of planning but you will still need to appreciate the complex world of business structures.
Whether you are a freelancer, contractor or a small business owner, you will have heard of the potential options available which include being a sole trader or a partnership, a limited company or a limited liability partnership.
Each of these business structures has their own characteristics which may, or may not, be right for the business you have in mind.
While you could alter your business structure in the years to come as it grows and develops, it is crucial both commercially and legally that you set off on the right foot.
By laying the proper foundations, you will help give your business the best chance of success and here we will explain the options for freelancers and contractors, as well as small business owners, in more detail.
Starting out as a sole trader
If you are starting out as a sole trader, then you and your business are effectively one and the same thing from a legal and tax perspective.
The big difference between a sole trader and becoming a limited company is that you are personally responsible for all aspects of the business, including any debts that are incurred.
All of the profits you make, minus the cost of sales, will be declared on your annual self-assessment tax return which has a deadline of January 31.
The turnover for a sole trader’s business will be classed as your personal income in the financial year, even if you are not paying yourself a salary or paying money into your personal bank account.
You will also need to pay National Insurance and income tax at the standard rates on the profits that your business makes.
While you do not have to register a sole trader business as such you must inform HM Revenue and Customs that you are self-employed and operating a business for tax purposes.
There are pros and cons to all business structures and for sole traders, they include being easy to set up and administer and there are fewer financial restrictions – it is easier to take money out of the business than it is from a limited company.
The other big benefit for a contractor or freelancer is that certain financial information will remain private – unlike the details of a limited company which will be made public.
Also, a sole trader business is easier to close down while closing a limited company can be costly and takes time, particularly if there are debts involved.
Start out as a partnership
If you decide to start out as a partnership then there is more than one owner but the business status is similar to that of being a sole trader.
The big difference is that each partner will have a specified share of the profits and also the liabilities and they will pay tax on their income.
The benefits of a partnership include shared responsibility so with more business owners each will share responsibility for the operation and financial aspects of the business.
Also, partnerships can be a flexible vehicle and are easier to form than a limited liability partnership.
Start a small business as a limited liability partnership
It may be that you want to start a small business as a limited liability partnership, and while it has the same characteristics as that of a conventional partnership, it also offers the limited liability of being an incorporated company.
Professional services firms tend to use a limited liability partnership, such as architects and solicitors, because there are benefits for doing so.
They include tax transparency because they are generally not taxed as corporations so there’s no need for paying corporation tax and each partner is taxed as if they are a self-employed individual through self-assessment.
Pros and cons for a freelancer becoming a limited company
There are pros and cons for a freelancer becoming a limited company and the big difference is that it becomes a separate legal entity.
Essentially, the company must be formed or incorporated and registered with Companies House.
The company is owned and controlled by its shareholders and shares can be allocated to any number of people when the firm is incorporated.
There’s more administration required for a limited company, including the filing of annual accounts with Companies House.
You will also need to file an annual corporation tax return but these can be dealt with easily and simply by experienced online accountancy firms.
The benefits of forming a limited company as a contractor, freelancer or a small business owner are mainly down to tax efficiencies and you will receive income from dividends and salary.
There’s also the reduced risk from liability, such as debts, and having a limited company offers a professional image to potential clients.
While this is a complex world of business structures, a lot depends on your personal circumstances and how ambitious you will be so deciding which entity is best from the outset will probably save lots of time and trouble further down the line should you decide to switch your business structure.
Fortunately, there are experts at biaccountancy.com who can help to talk over the pros and cons and deal with the accounts and bookkeeping as well.