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Company Structure

Would it be better for you to be self-employed, or to be a director of a limited company? What difference does it make? Each legal entity has advantages and disadvantages. Here we have set out some of the obligations and liabilities, pros and cons associated with each option.

* Sole Trader

* Partnership

* Limited Liability Partnership

* Limited Company

If you are thinking about setting up your own business and you are likely to be working as a contractor for larger companies, you need to be aware of Inland Revenue's legislation known as IR35.

Sole Trader (Self-Employed)

This is a business owned by one person. Legally, the person and the business are one and the same. All financial risks are taken by that person and all that person's assets are included in that risk.

Obligations

Keeping Records

If you are self-employed, you need to keep careful records. You must define personal transactions (e.g taking stuff from your own stock), and if you are working from home you must be careful about apportioning what is for business and what is for private use (e.g utilities bills.) If you use a car for work purposes it is a good idea to keep a log-book, detailing business and private use of that car. You will find these records useful when you are filling in your tax return. (If you are working from home, you also need to think carefully about insurance, and Council Tax).

Tax and National Insurance

When you first set up the business you must inform Inland Revenue that you are self-employed. You can find more information about how to do this, including a form you can use to notify Inland Revenue about your business, in Leaflet P/SE/1 "Thinking of Starting a Business?" You will also need to fill in a Self Assessment Tax Return. The latest submission date for tax returns is 31st of January. There are financial penalties for late submission.

If you take on staff, you will have the additional responsibility of deducting Income Tax and Class 1 National Insurance Contributions from their pay, and paying it along with your Employer's Contribution to Inland Revenue, under the Pay As You Earn scheme. For more information see the Employing Someone page.

To download a copy of a guidance leaflet and the necessary registration forms from the Inland Revenue Web Site please click the link below.

www.hmrc.gov.uk/forms/cwf1.pdf -

Liabilities

As a sole trader you are totally liable for any debts or legal compensation your business becomes liable for. Make sure you have adequate insurance. Without insurance you could lose everything.

National Insurance

Class 2 NICs: These contributions are payable at a fixed weekly rate unless you have an exemption certificate*. You can choose to pay these monthly by Direct Debit. Otherwise you will be sent a quarterly bill. For more information see the National Insurance Contributions for the Self-Employed (class 2 and 4) page. *If your profit is below £4,215 per year you can apply for exemption from paying class 2 NIC contributions.

Class 2 NIC Rates 2004 - 2005 are a flat rate of: £2.05 per week

Class 4 NICs: These contributions are payable on profits between the Lower Profit Limit and the Upper Profit Limit. They are collected when you send in your self-assessment returns. For more information see the National Insurance Contributions for the Self-Employed (class 2 and 4) page.

Class 4 NIC Rates 2004-2005 are based on 8% of profits between the limits

Lower Profit Limit £4,745 Upper Profit Limit £31,720

1% above £31,720 per year.

Class 1 NICs: If you have staff you have the additional liability of Class 1 National Insurance Contributions which include the Employer's Contribution For more information see the Employing Someone page.

It is a very good idea to put money aside every month, to pay these contributions a table of how much Inland revenue recommend to set aside may be found in the Business Answers section

Pros

If you are operating as a sole trader you have almost complete control over how the business is run. You can make decisions (as long as they are legal!) without interference.

The administrative costs of running a sole business are small.

You will need to keep records for Inland Revenue (and also for VAT if you are VAT registered), but there are no other legal requirements.

Cons

All your personal assets are at risk if the business fails. Personal bankruptcy can occur.

Partnership (Self-Employed)

A partnership is a business run by two or more people together. There should be a written agreement detailing this arrangement. Profits are usually shared between partners according to the agreement. Although profits may be shared unequally, liabilities which may arise are shared jointly. This is something that everyone involved should be very clear about. Even if you only own 1% of the business you will still be responsible for 100% of the liability.

A partnership is a very risky type of business to get involved in, just because of all the potential for conflict, and the financial effect conflict between partners would be likely to have on the business. However, now the Limited Liability Partnerships Act has received Royal Approval and will become Law by the end of the year. There are a number of advantages to LLP including limiting liability (as with a Limited Company) and the tax advantages of a Partnership. See information below

To download a copy of a guidance leaflet and the necessary registration forms from the Inland Revenue Web Site please click the link below.

www.hmrc.gov.uk/forms/cwf1.pdf -

Obligations

Your obligations are the same as for a Sole Trader (see above.)

Liabilities

Your liabilities are the same as for a Sole Trader (see above.)

Pros

Often more money can be raised to start the business if more than one person is involved.

You will need to keep records for Inland Revenue (and also for VAT if you are VAT registered), but there are no other legal requirements. Each partner should submit a P/SE/1 and you are taxed as an individual. If you leave the partenership your tax liability will follow you (unlike in the past when the remaining partner had to pay it)

The workload can be shared.

Cons

All personal assets of each partner are at risk if the business fails. Personal bankruptcy can occur.

Decisions are taken jointly. The agreement may specify different levels of decision making for each partner. Either way a stalemate could easily arise, or the decision making process could be hampered, if a decision cannot be reached without the major shareholder present.

Limited Liability Partnership

A LLP gives the benefits of Limited Liability in that it can protect your existing personal assets, while giving many of the Tax advantages of a sole trader partnership

You have to register with Companies House, the method is similar to registering a company.

Liability:

The LLP will be a separate legal entity and while the LLP itself will be liable for the full extent of its assets the liability of the members will be limited. Under certain circumstances, however, claims for economic loss could be made against individual members who have been negligent. Any such claim would be a civil action outside the contract as the party would have contracted with the LLP.

Management:

The business is controlled by the 'designated members' (who have a similar responsibility to a directors / secretary of a Ltd Company) and the 'members'.

Finance:

Capital is provided by the members, LLP's are similar to 'Partnerships' or 'Sole Traders' in this respect.

Profits:

Incomes derived by the members will be closer to that of a 'Partnership' than to the dividends paid by companies.

Taxes Etc.:

An LLP will be taxed as a 'Partnership'. The members will provide working capital and share any profits.

Continuity:

The company is a legal entity in it's own right.

Details:

An LLP is an alternative corporate business vehicle (being introduced April 6th 2001) that gives the benefits of limited liability but allows its members the flexibility of organising their internal structure as a traditional partnership.

Any new or existing firm of two or more persons will be able to incorporate as an LLP in England, Scotland or Wales. It is not possible to convert a company to an LLP or vice versa. LLP's are not available to Charities, there must be a view to profit.

LLP's are similar to companies in the respect that they will be required to provide financial information equivalent to that of companies, including the filing of annual accounts. Also they must notify any changes to:

The LLP membership; members' names & addresses; the Registered office.

It is an alternative corporate business vehicle that gives the benefits of limited liability but allows its members the flexibility of organising their internal structure as a traditional partnership.

In autumn 2000, Companies House commissioned independent market research to investigate demand for LLP incorporation.

The results of this research indicate that demand will come principally from existing partnerships, although there is also significant interest amongst sole traders and existing limited companies.

The research also shows that Accountants and Solicitors will be well represented amongst early adopters of LLP status.

The Limited Liability Partnerships Act 2000 came into force on 6 April 2001.

Designated members are responsible for carrying out certain duties including some of those that would normally be carried out by a company director or secretary. They include such things as:

• Signing the annual accounts

• Filing the annual accounts and annual returns with Companies House

• In the event of Insolvency proceedings, providing any statement setting out the affairs of the business i.e. assets, debts and liabilities.

Although the above duties are specifically with the responsibility of designated members, the LLP regulations will provide for any member of the LLP who "knowingly and wilfully authorises or permits a default" to be subject to a financial penalty (as set out in Section 730(5) of the Companies Act 1985, Schedule 24).

They are similar to those of a company. LLPs will be required to provide financial information equivalent to that of companies including the filing of annual accounts. Among other things, they will also be required to:

• File an annual return

• Notify any changes to the LLP's membership

• Notify any changes to their members names & residential addresses

• Notify any change to their Registered Office address

The LLP legislation does not allow for a 'conversion process' - in the way that a limited company can convert to PLC status under the Companies Act, for example.

Anyone with a current limited company wishing to transfer their existing company name to a new LLP should contact Stuart Morgan (details below). The process will involve a closely controlled company change of name and an LLP incorporation. Establishing contact prior to submitting the necessary forms will help ensure that this process is completed as smoothly as possible.

Incorporation will be by registration at Companies House, similar to the way in which one becomes a company.

The forms for LLPs will, in the main, follow closely those for companies, except they will have an LLP prefix. Guidance booklets will be issued covering the filing requirements in respect of LLPs in England/Wales and for LLPs in Scotland.

These forms may be downloaded from the following link

An LLP will be taxed as a partnership. The internal structure of the LLP will be similar to that of a partnership. The members will provide working capital and will share any profits. Income derived by the members from the LLP will be closer to that of a partnership than to the dividends paid by companies. The Bill also provides that any partnership converting to an LLP will receive relief from stamp duty on any property transferred in the first year, subject to conditions. Members will be liable to pay Class 2 and Class 4 National Insurance contributions. For further information on Tax and National Insurance please visit the Inland Revenue Website: www.hmrc.gov.uk

The LLP will be a separate legal entity and while the LLP itself will be liable for the full extent of its assets the liability of the members will be limited.

In the main, any third party would usually contract with the LLP rather than with the members themselves and in those circumstances it would be the LLP which is liable.

It would though, under certain circumstances, be possible to bring a claim for economic loss against an individual member who has been negligent. Any such claim would be a civil action outside the contract as the party would have contracted with the LLP. The outcome of any such claim would not be easy to forecast but recent case law suggests that the courts would, when making any decision, have regard as to whether or not the LLP member assumed personal responsibility for the advice, whether the client relied on the assumption of responsibility and whether such reliance was reasonable.

Limited Company

Unlike a Sole Trader or a Partnership, the Limited company is legally a separate entity in its own right. The directors and shareholders have limited liability. When a limited company is created it will have an Authorised Shareholding which specifies the limit of a shareholders liability. If all shares have been issued then shareholders are not liable for any more debts that the company may accrue. This is definitely the most sensible option if capital is being put into the business by anyone who is not involved in running it. (i.e. shareholders) For information about setting up a Limited Company, have a look at our Company Formation page or follow this link

Obligations

Accountability

You have to hold an Annual General Meeting (AGM) for all the share holders, within 18 months of setting up the company, and at least every 15 months after that. These meetings must receive, and approve, Annual Reports from directors and auditors. These reports must include summaries of the accounts, names of the directors, details about the shareholders, and other information. At these meetings the shareholders must also elect directors and auditors.

You must also submit an Annual Return to the Companies Registration Office, summarising the information included in the Annual Reports. These details are displayed at Companies House, where they are available for public inspection.

Staff

A limited company always has staff, because a director of a company is considered an employee of the company, and a limited company must have at least 1 director, and a company secretary. For more information have a look at the Company Directors and Secretaries page, in the Companies House section.

Tax and National Insurance

Because a limited company always has staff it must always operate a PAYE scheme. This should be set up at the same time as the company's limited status. If you are a director of a limited company, bear in mind that there is a different set of rules for the payment of Class 1 National Insurance Contributions by directors. For more information on this see the Class 1 NICs for Directors page. Correct payment of income tax and National Insurance is the responsibility of the company director/s. If you are a director you need to make yourself aware of the appropriate legislation, because you cannot plead ignorance.

Liabilities

National Insurance Contributions

Class 1 NICs: You will have to pay the Employer's Contribution part of the Class 1 NICs for all employees.

Corporation Tax

As a Limited Company, you will have to pay Corporation Tax on all profits.

Pros

Limited liability can usually protect directors, who act in good faith, from legal actions brought against them.

Cons

There is considerably more administration involved in running a Limited Company than there is for a Partnership or Sole Trader.

As mentioned above, even with no other staff, the "owner" or director of the company is considered to be an employee of the company, therefore the more expensive Class 1 National Insurance Contributions must be paid.

You cannot keep your business affairs private. You have to hold an Annual General Meeting (AGM) for all the share holders. You must also submit an Annual Reports to the Companies Registration Office, along with a fee (currently £15.00)

Conclusion

As a rule of thumb you are usually better off, from a Tax and NI point of view, to set up as a sole trader or partnership - however few partnerships outlast the business and people who you have known for years, as friends, often turn out to be terrible business partners.

The new Limited Partnership may be the answer to this when it finally becomes Law. Limited Liability (in a Limited Company) should be looked at closely when you are dealing with high incoming costs, such as computer sales or design and print, where the gain is a lot lower than the risk if a customer should default on payment. However if you are selling mainly time, or a high profit item, consider the tax advantages of sole trader or partnership.

limited company shareholders agreement

You may need to consider a shareholders agreement, for further information click here

 

 

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