Sole Trader or Limited Company? Should I be VAT Registered? Starting your own business inevitable means wading through a jungle of jargon. Sorting out tax, insurance and legislation is an intimidating feat for any budding entrepreneur. Here’s our step-by step guide to steer you through the world of red tape so you can focus on what you do best.
Step 1) Choose your Legal Structure
The first hurdle is choosing whether to register as a sole trader, limited company or a partnership. We’ve have put together a handy comparison of each.
a) Sole Trader
The business will be completely yours to manage as you will technically be self-employed, and therefore you can keep all of the profits after tax. Just because you’re a sole-trader doesn’t mean you have to work alone. You can employ people, you’ll just be responsible for the business and any losses it incurs. Now let’s talk tax. The main things you’ll have to submit are the Self-Assessment tax return each year, income tax on your profits and also National Insurance.
Sole Trader is a very popular choice for small businesses; anything from hairdressers, shop owners, construction and B&B’s can register to be a sole-trader. You can hire solicitors, accountants or choose from various online software available to help you run your business.
Pros of setting up as a sole trader
- You will have complete control over how the business is run.
- This type of business is by far the most simple to set up. There is much less red tape and regulations than other types of companies.
- If your business grows, you can always convert to a limited company.
- You won’t have to prepare annual accounts as expenses and income are added to the tax return.
Cons of setting up as a sole trader
- Your personal finances may be at risk if the business runs up debts and it fails. This is called unlimited liability
- If you are sick, on holiday or unable to work, the business and therefore income comes to a stop.
b) Limited Company
So what is a limited company? Basically, it is a separate organisation which runs your business, meaning your personal finances aren’t connected. It is the organisation which is thus responsible for any losses and owns any profit it makes. This profit can be shared amongst the members who own shares in the company. To set up a limited company, you’ll need to submit a registered office address as well as details of the Director and Shareholder details. There must be a minimum of one director and one shareholder in the business.
- Limited by Shares.
This is the most common type of limited company and means a shareholder is responsible for shares they own but haven’t paid for. A shareholder can own 20 shares, but has only paid in full for 15. If the company goes bust before they have paid off any more shares, the shareholder is financially responsible for the 5 shares they haven’t paid for yet.
- Private Limited Company
Shareholders back the company up to a certain amount if the business fails, making it a popular choice for independent coffee shops and cafes etc.
- Public Limited Company
More suited to larger businesses, shares are bought and sold on the Stock Exchange.
Pros of setting up as a limited company
- You might be likely to pay less personal tax, as small businesses fall under the ‘small profits rate’ of tax. As the director of the limited company, you can choose to only take a small salary and the rest through dividends
- You are not personally liable if things go wrong
Cons of setting up as a limited company
- There are increased costs in time and money when setting up a limited company.
- Dividends do not go towards pensions. So you are paying less tax, however, they don’t count as relevant earnings for pension contributions
c) Business Partnership
- Ordinary Business Partnerships
You and your business partners personally share responsibility for the business; you can share and keep the profits after tax but you are each personally responsible for any losses or expenditure. However, a ‘partner’ doesn’t actually have to be a person – a limited company can act as a legal person for you to share financial responsibility with.
- Limited Liability Partnerships
However, if you don’t want to personally be financially responsible for the business, a limited liability partnership could be the way forward. They are liable only for the money they invested in the business.
Pros of a Business Partnership
- Shared financial responsibility of the business
- One partner may have strengths that other doesn’t and vice versa
Cons of a Business Partnership
- Conflicts over decisions and share of profits can result in disputes.
d) Unincorporated Association
If you want to set up an organisation that is non-profit, such as a local sports club then you don’t need to register it. The group members themselves are responsible for debts and expenditure.
Step 2) Company Registration
- Registering your Company Name
You have to find a unique name for your business – check out the Companies House register to see what’s been taken. There are other rules to consider before naming your business as it can’t be offensive or suggest a connection with the government. The Gov website has detailed requirements for you to consider when choosing a name for your business.
If you’re starting your own business and are opting for sole-trader status, you must register with HMRC. You can do this online and can even use their tax calculator to help work out what you need to pay which will help writing your business plan. You will be responsible for keeping all records of sales and bills, so it is vital to keep organised!
- Getting your Company Registration Number
Once your business is registered with Companies House, you will receive a Company Registration Number – which is vital not to lose! You’ll need the number in case you ever need to change the company name, registered office address or file your annual return.
Step 3) Registering for VAT
If your small business passes the VAT threshold (at the moment it is £83,000) in annual turnover, you must register for VAT. It is a tax charged on goods and services in the UK and goods that are imported from the EU and outside the EU. Different goods and services charge different rates of VAT – for example, if you’re opening a greengrocers or a children’s clothes shop then these fall under reduced tax rates. You can check out what other goods and services fall under reduced VAT on the GOV.uk website.
Step 4) Taking your Wage after Tax
New businesses sometimes get a nasty shock at the end of the tax year after they’ve filled out the tax return and underestimated how much they have to pay. To avoid this and to get a more realistic picture of how much money you have to live off, it’s best to open another account and deposit approximately 25% of all net income into it. This way throughout the year, you can be reassured that once April rolls around you have enough to cover the tax return.
Finally – remember you’re not alone! There are many approved partners of Companies House who can advise and help you through the registration process. You can invest in accountants and solicitors who specialise in start-ups and small businesses to give you a bit more confidence.