Legal structure of your business
Around 4 Million people in the UK today work for themselves through a number of different legal structures. That equates to approximately 1 in 7, each of whom are responsible for setting up and maintaining business records, registering with HM Revenue & Customs (HMRC) for tax and national insurance contributions (NIC’s), value added tax (VAT) if appropriate, corporation tax if appropriate and paying over the necessary amounts as and when they fall due. This document guides you through setting up your business and assists you to complete the administration in a proper manner right from the start.
When you start a business the first decision that you must make is deciding the right legal structure to ensure that your business is set up in a correct legal manner with HM Revenue & Customs and other authorities. For example, your contractual terms of how you do business, your business banking arrangements, your business insurances, registering your services with the relevant authorities. In order to make the correct decision you need to take into account the way that you conduct your business as this will affect:-
Overview of the various legal structures
Self Employed/Sole Trader
Self Employed/Sole Trader/CIS Scheme
Self Employed Partner in Partnership
Self Employed Partner in Partnership/CIS Scheme
Self Employed Partner in Limited Liability Partnership/inside IR35
Self Employed Partner in Limited Liability Partnership/outside IR35
Self Employed Partner in Limited Liability Partnership/CIS Scheme/inside IR35
Self Employed Partner in Limited Liability Partnership/CIS Scheme/outside IR35
Employed Director of Limited Liability Company/inside IR35
Employed Director of Limited Liability Company/outside IR35
Employed Director of Limited Liability Company/CIS Scheme/inside IR35
Employed Director of Limited Liability Company/CIS Scheme/outside IR35
Employee
Self Employed / Sole Trader
A self employed person is one who owns a business, for example John Smith trading as JS Plumbing and Heating. Most people who set up in business start up as a sole trader, the technical term for people who work for themselves. Being a sole trader is generally the simplest way to run a business and doesn’t involve paying any registration fees for company formation and tax purposes. Keeping records and accounts is relatively straightforward. The advantages of being a sole trader include independence; ease of set up and running and all profits are retained by you. Self employed people do not pay PAYE instead they pay tax on their profits under what is called Schedule D. There are definite advantages in paying tax under Schedule D as there are more opportunities for self employed people to reduce their tax bills than an employed person. There are more expenses that can be claimed and they are somewhat easier to claim. For example most self employed people operate from their home and are able to claim against their profits a proportion of their household expenses; heat, light, and telephone. In addition there is loss relief which can be set against other taxable income or, in the early years of business, can be carried back against your total income for the previous three years. The disadvantages include lack of support, unlimited liability and the fact that you are personally responsible for any debts that are incurred by your business.
However you should be aware that businesses you contract with, will often insist that you are paid net of tax (like an employee) or operate through a limited liability company. For example, if you find work through an employment agency, the agency is legally obliged to deduct tax and NIC at source or request that you form your own limited liability company.
The Construction Industry Scheme (CIS) follows similar lines with mainstream contractors withholding a percentage of the earnings of their sub-contractors and paying the deduction to HMRC as tax on account. Often the choice of being self employed or operating through a limited liability company is taken out of your hands by the employer or agency. In these circumstances you or the person you work for cannot simply choose whether you will be self employed or an employee, it will depend on the terms, conditions and the working arrangements of the engagement.
You must register as self employed with HMRC, within 3 months of the last day of the month in which the business begins. If you don’t register, HMRC charges a penalty of £100.00. You can register by calling the HMRC helpline on 0845 915 4515 or by using this link to download this form from the HMRC website.
http://www.hmrc.gov.uk/forms/cwf1.pdf
You should then post the completed form to HMRC National Insurance Contributions Office, CAAT, Longbenton, Newcastle upon Tyne, NE98 1ZZ.
Example If you are self employed NIC will be calculated as follows:
Class 2 - self employed £2.30 per week
Small earnings exception £4,825 per year
Class 4 - 8% of the profit before drawings between £ 7,475.00 and £ 42,475 and 2% thereafter
Lower limit of profits £ 7,475.00
Upper limit of profits £42,475.00
Class 2 – A flat rate currently £2.30 per week payable by self employed persons or by individuals who have a second source of self employed income. If your earnings from self employment are less than £4,825 per annum you may apply at the local tax office to be exempted on the grounds of small earnings.
Class 4 – Self employed persons pay class 4 contributions in addition to Class 2. Class 4 contributions are earnings related and are assessed at the same time as your income tax is calculated. A self employed person is obliged to pay 8% of his profit chargeable to tax between £ 7,475 and £42,475. On profits exceeding £42,475, 2% is due on the balance thereafter. If you are obliged to pay class 1 as an employee and you have self employed earnings subject to Class 2 and 4 you should contact Solo Accounting or an equally suitably qualified Accountant for advice.
Income Tax - With effect from 5th April 2011 you will pay tax at the basic rate of 20% on the first £35,000 of income. Your Income tax will be calculated as follows: Regardless of whether you are a sole trader, a partner in a partnership or a limited company director, everyone is entitled to a personal tax allowance. A personal allowance is the amount of money that you can earn before you have to pay income tax. In the 2010/2011 tax year which runs from 6th April 2010 to 5th April 2011 you can earn £7,475 before you start paying income tax. Over £7,475 you pay basic rate tax at 20%. You will only pay higher rate tax on the balance over £42,475.
Subcontractors providing services in the construction industry
If you are a subcontractor working in the construction industry you will normally have tax deducted from your earnings before the money is paid to you. If you have not registered for tax with HMRC the contractor deducts tax from your earnings at the rate of 30%. If you have registered for tax the contractor deducts tax from your earnings at 20%. If you had a tax certificate CIS5, CIS5 (Partner) or CIS6 you keep gross payment status and therefore no tax is deducted at source.
http://www.hmrc.gov.uk/cis/whatis-cis.htm#1
Self Employed Partnerships
Please read the section for sole traders and consider the following additional information. When two or more individuals get together and start a business they often form a partnership. When you are in a partnership it is advisable to have a formal partnership deed drawn up by a Solicitor. This is a legal document that sets out what each partner is responsible for and what he or she can expect from the business. This is particularly important if your wife or husband is a partner as your wife or husband can be held jointly and severally responsible for any business debts incurred. This could put family assets including your home in jeopardy. In the case of divorce the business partnership could be seriously affected.
In a partnership each partner is self employed and takes a share of the profits and each partner is personally responsible for any and potentially all of the business debts/liabilities. Business partners should be chosen very carefully and partnerships should not be entered into lightly. Usually partners share the decision making and management responsibilities of the business. If a partner resigns, dies or retires this could lead to dissolution of the partnership, much will depend on what was documented in the formal partnership deed at the outset. One partner must be appointed to complete the partnership tax return on behalf of the partnership and to file it on time. This tax return will clearly state the actual profits taken by the partners and this information is used to account for income tax and NI in the same way described for self employed/sole traders.
You should open a separate bank account for your business which should be in the partnership name. The annual turnover limits for 2010/2011 above which you must register for VAT are £73,000. The deregistration limits are £2000 less than these figures. The standard prevailing rate for VAT is 20%. Under the self assessment rules you must keep books and records for 5 years and 10 months from the end of the tax year.
Limited Liability Partnerships
Please read the section for sole traders and partnerships and then consider the following additional information. Similar to a normal partnership, a deed of partnership is drawn up, but the individual members have limited liabilities for debts incurred by the business, up to the value each partner invested. More administrative duties are involved and the business operates more like a limited company than a normal business partnership. Individuals or existing businesses can be members of limited liability partnership and it must have at least two members. A member of the partnership should be designated to deal with preparation of the annual accounts and for making annual returns etc. Once again you should open a business bank account for your business which should be in the limited partnership name.
Limited Liability Companies
You can start a business by forming a limited liability company. If you trade as a limited liability company and you are a Director and shareholder of the company, you are an employee and are not self employed. A Limited Liability company exists in its own right and is owned by its shareholders. The funds in the company belong to the company and are separate from the personal finances of the company's owners. The company is managed by its Directors who may or may not also be shareholders. All companies must have at least one Director and may also have a Company Secretary, although this is no longer necessary from 2008 onwards. If the company fails and becomes insolvent (i.e. its liabilities are greater than its assets) then the liability of the shareholders is limited to the value of their investment in the share capital of the business. In this way a shareholders' personal assets and private homes for example are protected. If however Directors have acted fraudulently, or contrary to the role and responsibilities of Directors laid out in the Companies Act, or if they choose to give personal guarantees to raise finance for example, then a shareholders personal assets may still be at risk. It is very common for shareholders to also be the company’s Directors and they often, therefore, receive remuneration as both dividends based upon a share of the retained profits after payment of corporation tax by the company and as employment income for which they pay class 1 NIC’s as well as income tax on their salaries.
An example of allowances and tax rates in respect of employment through a limited liability company can be found on the next page "Allowances and Tax Rates".