Who’s business is it anyway?

A Mum's guide to types of businesses
January 2010 | written by Sam Thewlis, Head of Editorial
 

An important consideration for any Mum starting up, or even continuing in business is which type of business vehicle to use. The terms can be complicated and the tax treatment confusing, so this is a quick guide to the main things to think about.

Unincorporated businesses

The Wikipedia.org defintions of the two main types of unincorporated business are a good starting point. A sole trader is “a person who trades by himself/herself without the use of a company structure or partners and bears alone full responsibility for the actions of the business.”

“A partnership is a type of business entity in which partners (owners) share with each other the profits or losses of the business. Partnerships are often favored over corporations for taxation purposes, as the partnership structure does not generally incur a tax on profits before it is distributed to the partners (i.e. there is no dividend tax levied). However, depending on the partnership structure and the jurisdiction in which it operates, owners of a partnership may be exposed to greater personal liability than they would as shareholders of a corporation.”

A sole trader or partnership is chargeable to income tax on profits earned by the business. Profit is not the same as the amount Bill Bloggs may take out of the business bank account which (if the business wants to remain afloat) is likely to be less than overall profit. Profit for tax purposes is also likely to be different from the accounts profit, as things like depreciation costs are not allowable for tax, but you may claim capital allowances instead.

Sole traders need to include their business details on their self-assessment tax return and partners not only need to include their partnership income, but the partnership also needs to complete its own specific partnership tax return as well. Sole traders and partners pay any income tax and class 4 national insurance contributions due on profits as part of the normal self-assessment system, with tax due on 31 January and possibly payments on account on 31 January and 31 July.

There are no formal reporting requirements for accounts of unincorporated businesses- provided the business records are correct and complete such that a tax return may be completed. There is also no obligation to file accounts for public inspection- the details of your business profits (or losses) should remain a closely guarded secret shared only with the taxman.

However, the major disadvantage of unincorporated businesses is the unlimited liability of the proprietor(s). If a sole trader’s business fails and is unable to pay its creditors, those creditors are perfectly within their rights to demand payment from the individual’s personal funds, and may even make a claim on his home. For partnerships, partners are similarly liable, but they are also jointly and severally liable to their other partners- in simple terms any one partner can be held responsible for the debts of the whole partnership or even debts incurred by another partner.

Incorporated businesses

“In the United Kingdom, a company with limited liability amongst its owners; that is, shareholders who are not liable for more than their investment in case of insolvency. In other words, an owner of a limited company would lose the value of his/her investment if the company declares bankruptcy, but would not be held liable for other outstanding debts. A limited company is the most common corporation structure in the United Kingdom and is designated by "Ltd" after its name”

Companies are, on the other hand, chargeable to corporation tax and liable to complete corporation tax returns. Other than large companies, who must make quarterly payments of corporation tax, normally any company liability is due nine months after the end of the accounting period. Note, however, that if an individual wants to extract cash from the company, there may be additional tax consequences, as this will need to be paid out normally as a salary or as a dividend, and may be chargeable to income tax in the individual’s hands.

There are strict accounting and reporting procedures for limited companies and accounts and shareholder information must be filed annually with Companies House. This information is publicly available to anyone who wants a look, including your customers and competitors.

The main advantage to a corporate structure is that the individual shareholder’s liability is limited, normally by shares or guarantee. This means that, should a company be unable to meet its debts, any disgruntled creditors have no recourse to come knocking on the shareholders’ doors. In practice, however, especially where small or newly established companies are concerned, creditors such as banks may require personal guarantees from the directors, and trade creditors may refuse to extend credit to reduce their risk.

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