The Different Business Models
The first thing that you will have to decide is what type of business you are going to have. There are four structures you should consider: Sole Trader, Unincorporated Partnership, Limited Company and Limited Liability Partnership.
Let us look at the merits and demerits of each of these structures:
Being a sole trader
is the simplest of all of the structures. It means that you are conducting your business in your own name but you will need a business bank account to ensure you keep your personal funds and those of the business separate. Annually a set of accounts will be produced and you will be taxed on the profit, whether you have drawn the profit into your personal account of not.
Assuming that you are already earning from employment you will be taxed at your marginal tax rate, currently 40% or 45% dependent on your level of income from employment.
An unlimited partnership
with a spouse is another way of working. Similar to a sole trader this allows you to split the profits between you and your spouse although you will have to be able to justify your spouse’s involvement. For example it may be that they are your secretary, taking phone calls, managing your appointment book, managing your accounts etc...
If they do not share your technical expertise then it is difficult to say your spouse is say a consultant surgeon, but medical secretaries are very skilled and sought after, so the more qualified in that role your spouse is, then the more you can justify a more equal share of the profits.
As unincorporated businesses a sole trader and a partnership have unlimited liability for their debts, indeed in an unincorporated partnership you become jointly and severally liable for the debts. So if you partner enters into a financial arrangement in the name of the partnership and reneges on the repayments, then you will become liable to make the repayment.
The underlying comment here is to be very careful who you go into partnership with and sometimes your spouse is not the right person.
This is where a Limited Liability Partnership (LLP)
comes into play. The difference is given in the nature of the entity. A separate business bank account is required and you do need to have at least two members.
Although it is a separate legal entity in the same way as a limited company, the members of an LLP are taxed as though it is an unincorporated partnership. This is clearly a disadvantage in many ways, especially when you are already a higher rate or top rate tax payer.
However there are reasons for choosing this structure if you have already established the partnership, or there is property that is within the partnership. There is little to change and transferring land and buildings from a partnership into an LLP does not attract Stamp Duty Land Tax.
The fourth structure is that of a limited company. A limited company is a separate legal entity to the owners and in theory the liability of the shareholders is limited. I say in theory because there are times when it is not.
A bank is unlikely to lend money to a small limited company without asking for a personal guarantee from the directors or the owners, and many suppliers will also ask for a guarantee too. As a professional you will have some form of liability insurance, but if you were negligent then you are not able to hide behind the limited company screen. So, all in all, limited liability is there in name but not always in practice.
With a limited company the company (as a third party) pays corporation tax with no reference to the marginal rate of tax that you, the owner, pay. This means that whatever the profits of the business the tax rate is currently 19% (2019-20).
However, if you are employed by the company, taking money out by way of salary will mean that you will have to incur PAYE and National Insurance on what you draw and the company will also have to pay Employers National Insurance too (currently 13.8%). If you are earning more than £50,000 per annum from your main employment or over £58,656 from both employments then you can apply for a deferment of National Insurance, which will reduce the amount you pay personally, but that does not apply to the Employer’s portion.
There is, however, a way to reduce the liability for National Insurance and that is to draw dividends. This is where the structure of the limited company is very important.
The owners of a limited company will own shares in the company and there will be a minimum of one share in issue. If you have 2 members (shareholders) there will be at least 2 shares in issue and so on. However it is possible for a member to own more than one share.
If, for example, a new company was formed with 100 Ordinary Shares of £1 each issued, then we could have 100 people owning 1 share each or 1 person owning all 100 shares, but more likely somewhere in between. If my spouse and I were the two shareholders then it is quite likely that one of us will own 2 shares more than the other (51:49), rather than owning an equal number (50:50).
Owning those 2 extra shares will mean that person will have control, as they own more than 50% and under company law can pass resolutions. There are certain resolutions that require a 75% majority which wouldn’t be possible even with the shareholdings at 51:49, but those resolutions are matters such as changing the name of the Company and agreeing to sell the Company.
Paying dividends is done on a per share basis. Thus if I have 51 shares and there is a dividend of £10 per share paid I will receive £510.
The first £2,000 of dividends received by an individual each tax year are free of tax (currently). If you are a basic rate tax payer, then you will pay 7.5% up to the point it takes you into higher rates, when it goes up to 32.5% and there is also an additional rate of 38.1% for those earning over £150,000. This tax is paid by the recipient of the dividend.
A limited company is probably the most tax efficient way of owning a business if you don’t want all of the profits of the business out and are happy for them to accumulate. But if you are already earning in excess of £100,000 and the profits of the business are say a further £100,000 and you would like to take the post-tax profits as a dividend then there is 19% Corporation tax on the £100,000 (£19,000) as well as approximately £50,000 of dividends where you will pay 32.5% (£16,250) and £31,000 where you will pay 38.1% (£11,811). A total of £47,061 or 47% of the profit.
It is important to ensure that you have the correct business model for your new business venture and the model you will chose will be the one that suits your needs best.
It is important that you use your accountant at this early stage. Commencing a business requires notifying HMRC within time specific deadlines. The accountant will know of these deadlines and will ensure that your business is set up in the correct way and all notifications have been made.
