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Sole Trader v Partnership v Limited Company (Correct 2001)

Business credibility

The rigours of setting up a limited company and the demands of company house provides ltd status with a little more credibility than as partnership or sole trader

Debts

If you are a sole trader you are liable for all your debts – you in fact have unlimited liability – this includes personal assets (e.g. car, furniture)

The same applies for partners although you may also be made liable for your partners’ debts as well

Limited company status limits liability to the amount you paid for your shares in the first place. Personal assets can only be touched if you have been trading fraudulently. However this protection can be illusory as business start-ups often depend on bank loans and overdrafts, a condition of which would be some form of personal guarantee on the loan.

How to Start Up

Sole Traders are easy to set up – all you have to do is inform your local inland revenue office (see Yellow Pages) or your local Contribution Agency. They will inform Customs & Excise who will send you the necessary VAT forms. Setting up as a sole trader involves the least formalities and can be done very quickly.

Setting up a partnership follows the same procedure, although it would be advisable to get a solicitor to comprise a written agreement covering profit split, work split, tax split, change in partners and other relevant issues

Limited companies can be started from scratch or bought off the peg for as little as £100 (there is a small fee for name changes). The company should be registered with Companies House. Once established you must adhere to the disclosure requirements of companies house which includes covers changes in company Directors or Secretaries, Annual Return and accounts.

Your Accounts

As a sole trader or partner you need to submit a statement of accounts, although law does not stipulate the exact format. If your turnover is less than £15,000 you need only submit a three line summary, for example:

Turnover:£13,847
Less Purchases and expenditure:£ 3,017
Net Profits£10,830

Self-assessment tax forms provide a set format for your accounts.

Limited Companies have to submit trading accounts, profit and loss accounts and a balance sheet. If your turnover is more than £90,000 you must submit an accountants report of your accounts, audited account are only required if turnover exceeds £350,000.

National Insurance

(all figures for 2000-2001 as non contracted out payments)

Sole Traders and Partners make national insurance payments in two ways:

i)Class 2 contributions – (£2.00 week flat rate)
ii)Class 4 contributions are payable for business profits (as defined by income tax return (i.e. after deducting capital allowances). The rate is currently 7% of profits between £4,385 and £27,820.

If you form a limited company you will become a director and therefore an employee of the company and will therefore have to pay Class 1 NIC as:

An employee: – 10% on earnings between £76.00 and £535 per week.

An employer: In addition to this the company must pay national insurance on all pay above the lower level of £76 at a rate of 12.2%.

Sole Traders and Partners pay less National Insurance than limited companies – for example:

A Director of a Limited company paying themselves £20,000 pa would pay as Class 1 National Insurance:

£1604 as an employee
+£1907 employers’ contribution
£3511

However a sole trader with £20,000 would only have to pay:

£ 104 Class 2 payments
£ 1093 Class 4 Payments
£ 1197

Tax on Profits

Sole Traders pay standard income tax on profits at lower rate 10%, basic rate 22% and higher rate 40%

Partners are taxed on their share of the profit as if they were sole traders.

As a Limited Company Director you will pay income tax on your salary as any normal employee and corporation tax on any profits left for the business. Corporation tax is currently levied at 20% for small companies. Many start ups will however pay less as anew rate of 10%has been introduced for companies with profits of up to £10,000.

It is likely that you will pay slightly less tax as a limited company.

Pensions

As a limited company the amount of tax-free contributions you can make to a pension is limitless, contributions can even exceed salary. As well as company contributions you can also invest up to 15% of your salary as a Director and get tax relief at the highest rate paid.

Sole traders and Partners you can only get tax relief is between 17.5% and 40% of your taxable profits

You get the best deal on pensions with a limited company

Raising Money

As a sole trader or partnership you have limited means of raising money – most of which depend on your relationship with your bank manager. It is also always possible to take on a (further) partner.

Limited Companies have a broader range of opportunities including selling shares in the company and, once you are expanding, seeking venture capital.

Selling Part of the Business

This is more difficult if you are a sole trader or in partnership, again the answer may be to take on a further partner. If a part of the business can easily be sectioned off you may wish to sell it as a going concern

Selling bits of a private company is easier as it can be done through selling shares

Co-Operatives

The management, mission and use of company assets should be controlled by the workforce

Co-operatives must be run democratically, you must therefore organise a voting system.

All profits should be shared by the workforce

There are four possible legal forms of co-operative:

Partnership
Limited company
Co-operative society registration – you will need 3 founder members. Best done through Co-operatives UK (CUK)
Company limited by guarantee (of its members)

Key Points

Forming a limited company has clear advantages: limited liability for debts, increased credibility, less tax, better pensions opportunities, more ways of raising finance and it’s easier to dispose of part of your business

Sole trader s and partnerships have less rules to adhere to with regard to accounts, they pay lower national insurance and enjoy better tax treatment of losses.

Partners should always seek a solicitor’s advice in drafting and agreement

Setting up as a sole trader is the easiest option, although it is not necessarily more profitable and carries more risk

APPENDIX 2

Legal Format: What type of company should you form?

ISSUE

SOLE TRADER
PARTNERSHIP

LIMITED COMPANY
Start up
Register as self–employedDeed of partnership
drawn upRegister with Registrar of companies.

Liability
UnlimitedUnlimitedLimited to money put into business.

Management
By ownerShared responsibilityBoard of directors and management team.

Raising Finance
Mainly personal money

Partners’ financeOwners finance, issuing of shares.
Records and Accounts
No strict accounting or audit required.
Records not available for public investigation.Accounting and audit requirements. Accounts open for public inspection.

Profits

Belong to ownerBelong to partnersDividends paid to shareholders.
Tax, National Insurance & Pensions
Profits are taxed whether drawn or not, possibly at higher rates, National Insurance cheaper, but in general fewer benefits. Tax deductible pension contributions restricted. Losses offset against tax on other income.Employee status PAYE, high National Insurance, but full benefits. Unlimited contributions to company pension. Corporation tax on company profits. Losses retained in company.

Continuity
If owner dies or retires business may go out of existence.

Partnership dissolved on death, retirement or bankruptcy.Perpetual existence.
Owner and company are not same entity.
Selling
Usually whole business sold
Possible to sell some or all shares!..