In the first of two articles on structuring a business, Adam Bernstein reports for HVP on what installers need to consider when first starting up a business.
Starting up a new business venture involves countless different thought processes. Decisions need to be made, often in quick succession. Fundamental to all of these is the form in which the business will trade – sole trader, partnership, or an incorporated limited company.
A sole trader
The simplest option is to start up as a sole trader, as it requires no registration other than with HMRC and appropriate professional bodies. It works for those who don’t need to raise large amounts of liquid cash to start trading with. Decisions are instant, whatever the sole trader earns they keep, they are taxed less, and a sole trader is able to hire staff.
Being a sole trader carries little in the way of bureaucracy other than compliance with the law on, say, tax (registering with HMRC as self-employed), health and safety, and employment law. But it’s not all plain sailing, as the business and owner are considered as one; if the business fails, the owner has to meet any outstanding debts and obligations.
Profits are taxed by HMRC as income, less expenses, and to an extent, the sole trader is no better off than an employee while shouldering business risk. As income rises, so does the tax due, with little opportunity to implement a tax saving strategy.
But the bonus is that, unlike an employee, sole traders can claim expenses against their tax bill. That, however, needs to be offset against the paperwork that needs to be submitted to HMRC, and a possible need to engage an accountant.
As for tax, Income Tax rates are banded. For 2018/19, up to £11,850 income is tax free under a personal allowance and the basic rate of 20% applies to income between £11,851 and £46,350. A higher rate of 40% applies between £46,351 and £150,000; and over £150,000 the rate is 45%.
The Personal Allowance starts to be removed at £100,000 and disappears at £123,700. On top of this comes Class 2 (£2.95 a week once profits are £6,205 or more a year) and Class 4 National Insurance (9% on profits between £8,424 and £46,350, 2% on profits over £46,350). The rates are different in Scotland – see gov.scot.
Incorporating a limited company
Incorporating a business – forming a limited company – gives it greater standing. It also gives owners and directors protection, limited liability, for their personal assets should the business fail, as the business will generally carry the can if it fails.
Once registered at Companies House, the regulator, the business becomes a separate entity from the individuals that own it. In exchange for limited liability, directors face markedly more administration.
The company must send full accounts and a tax return to HMRC annually and must also make monthly PAYE payments for employees’ income tax (PAYE) and national insurance. There’s also the obligation to send accounts and an annual return to Companies House.
A key point to note is that the business tax regime is more favourable for companies than it is for a sole trader or partnership. This is because companies only pay corporation tax of 19% (2018/19) on the profits.
Directors and others pay Income Tax and National Insurance on their salary. However, many directors extract money via dividends with no National Insurance.
While the effect of this has been watered down by a tax on dividends over £2,000, directors can choose to pay dividends when it suits them (so as to stay below the higher rate tax thresholds), or can assign shares, and therefore dividends, to a partner or family member so that higher rate tax can be avoided.
The rates for Income Tax are the same as those noted for sole traders. Class 1 National Insurance is (generally) 12% on income of £162 to £892 a week, and 2% on income over £892 a week.
Forming a company
It’s very easy to register a new limited company and it can be done online at www.gov.uk/limited-company-formation in 24 hours.
However, before registering, a company name is needed (there are rules on this), as is an address for the company. It should name at least one person as a director, detail the shares that the company will issue, and have an SIC code (business category) that accurately describes the business (see resources.companieshouse.gov.uk/sic).
The shareholders will need to adopt a ‘memorandum and articles of association’ – rules that outline how the company will be governed and the powers that the directors have. All of this can be found through on the gov.uk website.
Running a company involves ongoing duties and obligations. Each year, the company must file annual accounts at Companies House. These accounts, with all information relating to the company, become public documents.
One option to keep matters private is to use micro-company accounts rather than full accounts – they satisfy the law but offer less information to readers.
A Confirmation Statement must be submitted every year to ensure that Companies House has the most up to date information about the company. This costs £13 online, or £40 if sent in on paper.
Naturally, the company’s financial position must be accurately reported to HMRC and any profits or taxable income declared and tax paid. The company must complete an annual Corporation Tax return with any tax paid due within nine months of the company’s year-end.
In summary, for many, the benefits of operating via limited company greatly outweigh the drawbacks. Even so, it’s important to not lose sight of the obligations.