How should I set up sole trader or company?
So you are thinking about setting up your own company or wondering whether you are trading through the best sort of company. There are basically three types of company you can trade through and they all have their pro’s and cons.
Sole trader
This is the simplest way to work for yourself and there has been much discussion in recent months about people reverting back to sole trader status, or setting up as a sole trader in preference due to increasing company tax rates of which more later. As a sole trader you pay tax on all of the profits you make in the business and for most small owner managed businesses there is tax of 20% and NI of 8% once a profit threshold of £6.5k and £5.7k respectively has been reached. However once profits exceed £43k you become subject to higher rate tax at 40% on the excess although NI is then only 1%. The NI rate is increasing by 0.5% in 2010/11 and a further 0.5% in the following year. In addition to this you also have to pay an NI “stamp” of £2.40 per week. This type of business is relatively simple to administer and a tax return is completed as a part of an individuals annual self assessment return. The business is linked to the individual and they are personally responsible for any debts of the business.
Limited company
To take yourself one step away from this liability a limited company is an entity in its own right and any contracts are with the company not the owners (shareholders) or managers (directors), although they do have other responsibilities in statute. A company is registered with Companies House and must send in accounts every year and also complete a tax return annually for submission to HMRC. The company is taxed at 21% on all of its profits and this rate will not increase as expected next tax year (2010/11), and it is for this reason and the NI increases that I consider the pendulum is not swinging back to sole trader status as much as expected. The people who work for the business are employees and are paid a salary, the shareholders however can be paid by way of salary and also dividend. As the name implies shareholders hold shares and the percentage of ownership is then fixed, it is this percentage that defines the proportion of a dividend that they receive. A dividend is paid to the shareholders as a payment for their investment in the business and this area should be considered carefully before setting up.
Partnerships
A simple partnership if effectively two or more sole traders working together sharing the profits of the business, however each one is liable for all of the business debts. In recent years Limited liability partnerships have become available which are separate entities from the partners (called members) and allow limited liability similarly to limited companies. For both types of partnership, the profits of the business are shared in line with a partnership agreement which should be written but may just be verbal. This allows more flexibility than a company where the dividend is fixed by the number of shares held. In a partnership the agreement can use different criteria (such as sales made) to split the profits between partners. This is therefore a more flexible option.
This is only a brief summary of some of the differences between the options available which may help you to decide which is the best option for you, or indeed a pointer to ask more questions before setting up. You should seek professional advice before proceeding but whatever you decide to do I hope you business is a great success.
