Limited Company, Sole Trader or Partnership?

One of the fundamental questions when starting a new business is; “Should I run my business as a sole trader, partnership or limited company”?

The Government have, in recent years, been herding us all in the direction of the limited company, as it allows them to monitor statistical business data, and enforce deadline compliance, via Companies House. In the majority of cases, therefore, under current legislation, it will be preferable to run your business as a limited company. Some of the benefits of doing so include:

Limited Liability

A limited company is a separate legal entity, distinct from ourselves as directors / shareholders. If your business fails, your house and other assets are not at risk (unless you have guaranteed any debts personally, or you have been guilty of fraud in your conduct as directors).

An alternative to the limited company is the limited liability partnership (LLP) which is favoured by some accountants. Whilst, as the name suggests, this will have the bonus of limited personal liability for partners, it will lack some of the other benefits of the limited company.

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The perception held by most people is that limited companies are larger entities, and this automatically gives increased credibility.

Taxation savings

Over the last few years, legislation has changed almost yearly. For some of that period, the first £10,000 of a limited company’s profits were tax free. Although this provision is not currently in force, the Small Companies Corporation Tax Rate presently stands at 21%, from 1 April 2008, for profits up to £300,000.

Currently, a self employed person will pay a basic rate of Income Tax of 20% (rising to 40% from £36,000 of income) plus 8% Class 4 National Insurance. This, obviously, represents a minimum saving of 7% on every penny earned for a limited company.

By way of illustration, a small, one person business, making £15,000 net profit a year will, at 2008/09 rates, pay £1,540 less in tax as a limited company, than as a sole trader. Even with the slightly increased accounts costs involved with a limited company, it can be well worth considering the change for those who are still operating as sole traders.

It’s also worth noting that, under Self Assessment, we pay our tax six monthly in advance. Corporation Tax, however, is currently paid 9 months after the year end, giving us some, potentially, quite favourable cash flow assistance, at a time when, let’s face it, most of us could use it.

As long as you actually pay tax (in other words, you earn more than the tax free threshold, currently £6,470 per annum) then the tax benefits of being a limited company will normally be significant, and one of the biggest misconceptions amongst new business owners is; “I’m too small to be a limited company.”

To all of you I would say; “You’re never too small to save tax!”
Ok, so that’s all very well, but how do you go about setting up a limited company? What does it involve? Is it more work or more expensive? Will you have to have an audit, register for VAT or find a company secretary?

The latest Companies Act has now completed the task of simplifying the limited company process, by, amongst other things, removing the requirement to have a company secretary, from 1 April 2008.

Other recent simplifications include:

1. The audit requirement for small companies has been removed for companies whose turnover is below £5.6 Million. Also, for companies of this size, we are not required to submit other than the most basic abbreviated accounts to Companies House, so our turnover, gross profit etc will not be a matter of public record.
2. The requirement to have two directors has now also been removed.
3. Limited companies were previously required to have at least two shareholders. This was, in reality, a bit of a pointless exercise, anyway, as business owners would simply issue 100 shares, 99 to themselves and 1 to their partner.

The net effect of all of this is that, from April this year, it is now possible to form and run a limited company with just one person, without the need to involve anyone else. The structure of the business, therefore, becomes as simple as that of a sole trader.

The other benefit of this is in the costs involved. The fact that most of us will never require an audit, will significantly reduce accountancy costs, and the simplified company structure means that you can now form a brand new limited company online from as little as £25.

By Alan Young

With some 25 years experience in the business and accounting sectors, Alan Young started his first business from home in 2000. Although his company continues to grow exponentially, much of his time is still dedicated to advising and supporting new and expanding enterprises within the home and small business sectors.