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What are the different business structures?
In the United Kingdom there are now more people than ever who own a business. As at 2020, the Department for Business, Energy and Industrial Strategy reported that there were 6 million private sector businesses registered with HMRC. This number includes a range of different business structures which meet the needs of varying business functions.
Setting up a business can feel like a complicated task when you are first starting out, as there are a lot of rules and tasks that you must think about. However, the first thing to consider when starting up, is the type of business structure you will use. Generally, there are four main business structures in the UK that you must choose from to register your business under.
- Sole Trader.
- Limited Company.
- Limited Liability Partnership.
The structure that you choose for your business will depend on the type of business that you will be running. If you are unsure of which structure will be most beneficial for your business, continue reading this guide to learn more about the features, responsibilities, advantages and disadvantages of each one.
Why businesses are structured in different ways?
Choosing the right legal business structure will impact on many areas of your business, such as paying taxes, levels of personal liability, your ability to generate finance, and the level of administration work you are required to complete and submit to HMRC. As businesses come in a range of functions and sizes, there is not a “one size fits all” approach to the structure.
The type of business structure you choose will depend on characteristics such as:
- The size of your business.
- The nature of your business.
- How many employees you have.
- Your profit margins.
- Whether or not you have a business partnership.
- Whether or not there are shareholders.
Selecting the right business structure will help you place your business in the optimal position for growth to achieve your objectives. Depending on the size of your business, you may require an accountant to support you with your initial set-up, and ongoing help to manage your finances and calculate the correct amount of tax and National Insurance contributions.
Having an accountant to help you manage these tasks can help you to minimise any room for error, so that you do not run into any issues with HMRC. You can assess whether or not to employ additional support by learning about the features and responsibilities of different business structures in the next section.
What are the features and responsibilities of different business structures?
We have included a table below that outlines a snapshot of the main features and responsibilities of the four different business structures. We will go on to explain each structure in more detail further on in this article.
|Run your own business independently.||Self-assessment tax return.|
|Partnership||Have a partner(s) support you to run your business.||Signed agreement detailing the partnership.
All partners register as self-employed.
All partners must submit a self-assessment tax return.
|Limited Company||You have limited liability for business debts and claims.
You and your business are viewed as separate entities.
|Register on Companies House.
Pay corporation tax.
Submit annual reports with Companies House and HMRC.
Submit annual company tax return.
|Limited Liability Partnership (LLP)||Have a partner(s) support you to run your business.
Have two designated partners.
You have limited liability for business debts and claims.
Limited liability against other partners.
|Have an LLP agreement to explain how the business will be run.
Register with Companies House.
Pay corporation Ttx.
Submit annual reports with Companies House and HMRC.
Submit annual company tax return.
On some occasions, your business might be registered as one of the above-named structures but operate under a sub-category, such as:
- Franchise – a franchise is a company that already exists and is well established. If you own a franchise, it means that you own the rights to use the established company’s business model and operate under their brand. A well-known example of a franchise company is McDonald’s.
- Freelancer – a freelancer is someone who can provide a service using their skills and knowledge (such as writing or photography). This form of self-employment works by accumulating clients to complete work for, and is often worked on a flexible basis.
- Social Enterprise – a social enterprise is a business that benefits society or the environment in some way. These businesses must be transparent in sharing the profits that they reinvest to ensure that they continue to work to benefit societal or environmental objectives.
- Charity – a charity has a similar mission to a social enterprise, in that it must operate for the good of society. However, it is different because its profits are generated through donations.
Operating your business as one of these functions includes different rules and responsibilities due to the nature of the businesses. You may wish to consult HMRC to find out more about these different functioning businesses.
Sole trader business structure
As a sole trader you will run your own business and work on a self-employed basis. This can be either as a freelancer, or a contractor. A freelancer almost always works on their own, and completes work for clients on their own terms by agreed deadlines. However, a contractor will usually work for a client on a self-employed basis, but on the client’s terms. This can include working at the client’s premises on set days and times. Despite being named as a sole trader, you are allowed to employ staff under this business structure, which would give you additional responsibilities.
To start a business as a sole trader you are required to inform HMRC of your business status, and to register for self-assessment tax returns. It is extremely important to notify HMRC of this for legal purposes; as if you are caught practising illegally, you are likely to be liable for some large fines for evading tax. It is your responsibility to pay the correct level of sole trader tax and National Insurance contributions. As at October 2021, all sole trader businesses are entitled to a £1000 tax-free allowance per financial year. Any profit made in addition to this is taxable if you have already used your personal tax-free allowance (which stands at £12,570 as at October 2021).
Being a sole trader is a simple business structure where you keep all of your business profits after tax, with no upper limit on your profits. This means that you can keep all profit that is earned by the business after tax deductions.
However, if your business is more profitable, falling in the higher tax bracket, it may not be the most efficient business structure for you. It is the most common business structure in the UK, with 59% of private sector businesses operating as a sole trader in 2019. This is due to its ease of start-up and minimal legal responsibilities.
However, there are risks involved because you and the business are viewed as one entity; so, you can be personally liable for any business losses, debts or negligence. This means that you will be forced to use your personal finances to resolve these issues, as there is no difference between you as a business owner and the company. Some client working roles, such as those in the care or legal sector, carry greater risk which will require you to have additional protection in place. This can include being DBS checked and having indemnity insurance cover.
- Simple to set up.
- Low level of administration responsibility. Your only requirement is to submit a self-assessment tax return.
- No registration fees.
- Keep all business profits (after tax deductions).
- You are held personally liable for business losses, debts and negligence as you and your business are viewed as one entity.
- Increased personal risk.
Partnership business structure
A partnership business structure has similar requirements and responsibilities to working as a sole trader, except you have one or more business partners. To have a partnership business structure, you must have a signed agreement outlining the agreed share in profits, losses, liabilities and level of ownership between you when setting up.
It should also include exit directions for if any partner decided to leave the business. It is the simplest business structure for two or more partners, but having an excessive number of partners may be better suited to a different business structure. Like with sole traders, all partners would hold personal liability for any unfortunate business debts, losses or negligence, as you and the business are viewed as one entity. In addition to the partnership agreement being completed, each partner in the business must individually register as being self-employed and complete their own individual tax returns to pay their own tax and National Insurance contributions.
When you register your partnership business structure you must all agree on a name for your business, register your business with HMRC, and choose a nominated partner. The nominated partner will be the person who is responsible for ensuring all administration tasks are completed on time (such as tax returns and record keeping).
- Easy to set up.
- You can have more than one business owner for support running your business.
- Increased liability on all parties. Each partner is held liable for any business or individual partners’ negligence.
Limited company business structure
You have probably heard of a limited company or may have seen the “LTD” appearing after a company name (if they are trading under their registered name). This is a private business that must have an appointed Director (or board of Directors) who would manage the business alongside any shareholders.
You can still register as a limited company if you are the only person working for the company, as you would simply appoint yourself as the Director. Some business owners find having a limited company more desirable than being a sole trader because it separates you from your business so that you are separate entities.
This means that your business has its own legal identity providing you with limited liability so you are not liable for business debts if there are issues in the future. In order to do this, you must create a company name and register it on Companies House which you must pay a small fee for. Registering in this way can also support your reputation as a business by legitimising your company among your customers, suppliers and stakeholders. As well as a fee, a limited company requires more administration than a sole trader or partnership structure.
The Director is responsible for completing the administration, including an annual audit, and filing of company accounts at the end of each financial year. It is this level of administration that often warrants the use of an accountant.
Due to the business having its own legal entity, it has its own bank account and is subject to corporation tax (which is a business tax paid similar to that of income tax). You can register for corporation tax at the same time as you register your business on Companies House, but unlike income tax, all of a business’s profits are subject to tax, so, there is no tax-free allowance. However, the government allow for expenses and deductions to be made that can lower the amount of corporation tax payable.
- You are provided with limited liability, so you are only liable for what you have invested into the company.
- Registering your business on Companies House appears more legitimate to your customers and stakeholders.
- Paying corporation tax can be more tax efficient that paying income tax in the higher tax bracket.
- Fees involved to register business.
- Increased administration responsibility that it likely to warrant the support of an accountant.
Limited liability partnership business structure
A limited liability partnership is similar to a partnership business structure, but with limited liability. You may have recognised a limited liability partnership company by the “LLP” initials coming after the company name (if they are trading under their registered name).
Like a limited company, an LLP ensures that liability to business partners is limited to whatever they have invested into the business, often making it a more desirable structure for larger businesses because each partner is not liable for the other partners’ negligence. At least two members must be named in the partnership agreement to report on your end of year accounts and keep up to date with general administration.
This type of business structure must be registered on Companies House, registered for corporation tax, and be notified to HMRC (similar to that of a limited company business structure). There has to be a minimum of two partners to form an LLP; one of which even can be a limited company instead of a physical person.
Like a partnership, an LLP must outline partner responsibilities in an agreement that will state how the business will be run, including the share of business profits. Each individual partner must complete their own self-assessment tax return to pay income tax on their income (such as their salary or dividends) from the business.
- You are not liable for your partners’ negligence.
- Paying company corporation tax can be more tax efficient that paying income tax in the higher tax bracket.
- Fees involved to register business.
- Increased administration responsibility.
- Two partners have the responsibility of submitting the end of year accounts so you must be able to trust them with this task.
As you can see, each business structure has different features that each match to different types of businesses. A sole trader is certainly the simplest structure to set up and manage, but may not be the best structure for a high cost start-up due to the personal liability.
That’s why it is important to consider the function of your business, as well as its size. A partnership structure is best suited to small businesses of two or more people, but requires you to have trust in your partners due to the personal liability involved. Larger companies are better suited to a limited company or limited liability partnership business structure, as they remove the risk of you being personally liable for business faults which could result in costly claims against you.
However, it is important to be aware of the increased administration responsibilities to ensure you do not get fined or even disqualified from being a company director. It is advised to seek financial advice and administrative support to ensure that you run your business legally with no issues; ensuing you are maximising your entitled benefits to reach your business goals.