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Starting a business: Choosing a legal structure for your business

Starting a business means deciding on the legal structure. But what are the options? What’s involved and what does it mean for you, personally and financially?

We’ve put together a brief guide to help you get to grips with legal structures* for businesses and what to do if you want to change the structure later on.

Starting a business: Choosing a legal structure for your business

Sole trader

Sole trader doesn’t just mean that you work on your own. You are allowed to employ staff, but you run your business as an individual. You are allowed to keep all the profits after you paid tax on them.

You’re personally responsible for any losses the business makes, and you must send a self-assessment tax return every year. You have to pay income tax on the profits and also National insurance. If you’re taking more than £83,000 a year, you also have to be VAT registered.

Limited Company

This is an organisation set up to run your business. The limited company is responsible for all it does, and its own finances, separate to your own personal finances. Any profit after Corporation Tax is owned by the company. Directors run the company and often, but not necessarily always, own shares and have a lot of legal responsibilities.

Types of limited company

  1. Limited by shares
    This is the most common type.  Shareholders’ responsibility for the company’s financial liabilities are limited to the value of the shares they own, but haven’t paid for yet. Directors, provided they haven’t broken the law, are not personally responsible for debts the business can’t pay.
  2. Private company limited by guarantee
    The company is financially backed up to s specified amount by shareholders and directors.
  3. Public limited company
    Shares are traded publicly on the market. Directors or shareholders are liable for all debts if things go wrong.

To set up a limited company, it must be registered with Companies House, and HMRC needs to be notified when the company starts business activities.

For each financial year the company has to put statutory accounts together, send Companies House a confirmation statement and send HMRC a Company Tax Return. If you expect to take more than £83,000 a year, the company also has to be VAT registered.

Directors of limited companies have to fill in a Self-Assessment tax return each year and pay tax and National Insurance through the PAYE system if they’re earning a salary.

Ordinary business partnership

Your business partner (s) and you share personal responsibility for the business. This doesn’t have to be an actual person, it can also be a limited company. You must register your company name with HMRC.

Profits can be shared between partners and each partner pays tax on their share (this is different in Scotland). This is the most suitable form if you do not want to be personally responsible for the business’ losses.

You are only personally responsible for your share of any losses made by the business and any bills for things you buy for the business.

The nominated partner has to send in a partnership Self-Assessment tax return every year. All the partners have to send a send a personal Self-Assessment tax return every year, pay Income Tax on their share of the partnership’s profits and pay National Insurance. The company has to be VAT registered if you expect takings of more than £83,000 a year.

Limited partnership and limited liability partnership

Limited partnerships

The liability for debts that the company can’t pay is split among the partners. General partners can be personally liable for all the partnerships’ debts while limited partners are only liable up to the amount initially invested. General partners also have to be responsible for managing the business.

Limited liability partnerships (LLPs)

Partners aren’t personally liable for debts. Liability is limited to the amount of money invested in the business. Responsibilities and share of the profits are set out in an LLP agreement,  but ‘Designated members’ have extra responsibilities.

The partnership has to send a partnership Self-Assessment tax return to HMRC and all the partners have to send a personal Self-Assessment tax return every year, pay Income Tax on their share of the partnership’s profits and pay National Insurance. If the partnership expect to take more than £83,000 per year, it has to be VAT registered also.

Unincorporated association

You can also set up an “unincorporated association” if you’re running a small organisation that won’t make any profit. This does not need to be registered and is free to set up.

Individual members are personally responsible for any debts and contractual obligations. If the association does make a profit, you’ll need to pay Corporation Tax and file a Company Tax Return in the same way as a limited company.

What if I want to change my business structure?

How to change your business structure depends on factors like if you’re VAT-registered and if you have any employees.

You can follow the normal steps to setting up a sole trader, business partnership, limited company, limited partnership or limited liability partnership (LLP).

You need to tell HMRC that you’re making a change, and, if you’re VAT-registered, this has to be within 30 days of the change or you’ll face a penalty. You will have to either cancel your VAT registration and re-register or transfer your existing VAT registration. This can be online or by post. You will also need to talk to HMRC if you employ people.

What if I sell my business or close an existing structure?

To no longer be a sole trader, you have to tell HMRC you’re no longer going to be self-employed so they can cancel your Class 2 NI contributions. You will still have to complete a Self-Assessment tax return, and the year after for your new business structure.

To close a business partnership, the nominated partner has to fill in a tax return when the partnership ends. If the business partnership is carrying on without you as a partner, you still have to complete a Self-Assessment tax return as usual. You’ll then start to submit tax returns the next year for your new business structure.


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