The alternative business structures are:
This is the simplest form of business structure since it can be established without legal formality.
The business of a sole trader is not distinguished from the proprietor’s personal affairs. If the business incurs debts which are unpaid, the creditors can seek repayment from the sole trader personally.
A partnership is similar in nature to a sole trader but involves two or more people working together.
A written agreement is essential so that all partners are aware of the terms of the partnership. Again, the business and personal affairs of the partners are not legally separate.
Sole traders and partnerships are often referred to as unincorporated businesses and the individual owners as self-employed.
A company is a legal entity in its own right, separate from the personal affairs of the owners and the directors.
A company provides protection from liability, which means that the creditors of the company cannot make a claim against the owners or the directors except in limited circumstances. Often this advantage is somewhat eroded because a bank, for example, may seek personal guarantees from the directors.
These potential advantages carry the downside of greater legal requirements and regulations that must be complied with.
LLPs are a halfway house between partnerships and companies.
They are taxed in the same way as a partnership but are legally a corporate body. This again gives some protection to the owners from the partnership’s creditors.
In this guide we consider the differing tax treatments of the alternatives but you should choose which structure is right for you based on more than just the tax issues alone.
A new business should register with HMRC on commencing to trade. Income tax is paid on the profits of the business. The amount that the proprietor, or a partner in a partnership, draws out of the business (referred to as ‘drawings’) is irrelevant.
From 2024/25 profits will be taxed on an actual tax year basis with 2023/24 being a transitional year. This means in a particular tax year profits arising from 6 April to 5 April will be taxed. Previously, for an ongoing business, a sole trader would have been taxed on the profits of the period of account ending in a tax year.
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Example |
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If the accounting period (or ‘year’) end is 31 August then, in the tax year 2024/25, broadly five months of the year ended 31 August 2024 and seven months of the year ended 31 August 2025 be taxed. Note if the year end was 31 March then, in the tax year 2024/25, the profits for the year ended 31 March 2025 will be taxed. |
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Tax Tip |
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Where an unincorporated businesses year end is not 31 March or 5 April, this can lead to difficulties in calculating the taxable profits for a tax year, particularly where there is not much time between finalising the accounts and the submission of the tax return. Additional calculations will also need to be done for the transitional period 2023/24. We would be happy to assist you with these.
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Profits are calculated using accepted accounting practices and crucially this means that profit is not necessarily simply receipts less payments. Instead it is income earned less expenses incurred. However see details of the optional cash basis for smaller unincorporated businesses.
Not all of the expenses that a business incurs are allowed to be deducted from income for tax purposes but most are. It is important that you keep proper and comprehensive business records so that relief may be claimed.
Trading and property income allowances of £1,000 per annum are available. Individuals with trading or property income below £1,000 do not need to declare or pay tax on that income. Those with income above the allowance are able to calculate their taxable profit either by deducting their expenses in the normal way or by simply deducting the relevant allowance.
An optional basis for calculating taxable profits is available to small unincorporated businesses. If an owner of a business decides to use the cash basis, the business profits would be taxed on cash receipts less cash payments of allowable expenses subject to a number of tax adjustments.
The optional scheme requires an election by the business owner and is only available where the business receipts are less than £150,000. Businesses can stay in the scheme up to a total business turnover of £300,000 per year.
A bit more detail of the scheme:
Do get in touch if you would like us to consider if this optional scheme is appropriate for you and your business.
When assets are purchased for the business, such as machinery, office equipment or motor vehicles, capital allowances are available. As with expenses, these are deducted from income to calculate taxable profit.
The AIA gives a 100% write off on most types of plant and machinery costs, but not cars, of up to £1,000,000 per annum. Special rules apply to accounting periods which straddle these dates. Any costs incurred in excess of the AIA will attract an annual ongoing allowance of 6% or 18% depending upon the type of asset.
Other allowances include a 100% allowance on certain low emission cars and a 3% Structures and Buildings Allowance.
Between 1 April 2021 and 31 March 2023, companies investing in qualifying new plant and machinery will benefit from new first year capital allowances.
Under this measure a company will be allowed to claim:
This relief is not available for unincorporated businesses.
To replace the super-deduction regime, the government has announced Full Expensing, a 100% FYA, which allows companies to deduct the cost of qualifying plant and machinery from their profits straight away with no expenditure limit. Qualifying expenditure will include most plant and machinery, as long as it is unused and not second-hand, but will not include cars. Full Expensing will be effective for acquisitions on or after 1 April 2023.
A 50% FYA for other plant and machinery including long life assets and integral features (known as special rate assets) will operate along similar lines.
Full Expensing and the 50% FYA are only available for companies and not for unincorporated businesses.
The tax allowance on a car purchase depends on CO2 emissions. Currently purchases of cars with emissions of up to 50g/km attract an 18% allowance and those in excess of 50g/km are only eligible for a 6% allowance. New zero emissions cars qualify for an allowance of 100%.
The self-employed may have to pay tax and NICs three times a year, namely:
In certain circumstances, the first two payments can be waived.
As an employer you will have many responsibilities. These will include employment law requirements which are not covered in this guide and HMRC requirements to report pay and benefits. Two other requirements place a further burden on employers.
Real Time Information (RTI) reporting is mandatory for broadly all employers.
Under RTI employers, or their agents, are required to make regular payroll submissions for each pay period during the year. The submissions detail payments made to and deductions made from employees. These submissions must generally be made on or before the date the amounts are paid to the employees.
The RTI submission details payments made which include salary, overtime and statutory payments such as statutory maternity pay. It also details the income tax, national insurance contributions (NICs) due together with other deductions such as student loan repayments.
The PAYE and NICs on salaries is payable monthly (or quarterly where the amount due is less than £1,500 per month).
Penalties apply to employers who fail to make returns on time. These penalties range from £100 to £400 per month depending on the size of the employer. Interest and penalties also apply for failing to pay on time.
The employer must also report details of expenses and benefits provided to employees. More information on the valuation of benefits is contained in the 'Tax and the Employee' section.
Pensions Auto Enrolment places obligations on employers to automatically enrol ‘workers’ into a work based pension scheme. Employers have to comply with their obligations which include:
All employers will need to contribute at least 3% of the ‘qualifying pensionable earnings’ for eligible jobholders.
If the employer only pays the employer’s minimum contribution, employees’ contributions are 5% as there is an overall minimum 8% contribution rate. The employee contributions may be paid net of basic rate tax depending on the type of pension scheme.
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Practical Tip |
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All employers have to comply with Auto Enrolment from when they first take on an employee. We can help you to deal with Auto Enrolment. |
Unlike sole traders and partnerships who pay tax on profits only (and drawings are ignored), companies have two layers of tax. The first is tax payable by directors and shareholders on money they take out of the company and the second is corporation tax which is due on the company’s profits.
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Practical Tip |
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If you operate as a limited company, there is a legal separation between you as the owner and the company itself. This means you cannot use the company bank account as if it were your own! This requires a certain amount of discipline without which all kinds of legal and tax related difficulties can occur. |
From April 2023, the rate of corporation tax will increase to 25% for companies with profits over £250,000. The 19% rate will become a small profits rate payable by companies with profits of £50,000 or less. Companies with profits between £50,001 and £250,000 will pay tax at the main rate reduced by a marginal relief, providing a gradual increase in the effective corporation tax rate.
In addition:
Directors of a company will normally be paid a salary and this is taxed under PAYE as for all employees. The cost of this, including the employer’s NICs, is generally an allowable expense of the company. Shareholders of the company in contrast may be rewarded by the payment of dividends on their shares.
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Tax Tip |
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In most small companies the directors and shareholders are one and the same and so they can choose the most tax efficient way to pay themselves. Using dividends can result in savings in NICs. This requires planning and needs to take account of the Dividend Allowance, which taxes dividends within the allowance at 0%, and dividend rates of tax. The Dividend Allowance is currently £1,000 so careful planning is required. Please talk to us to decide what is appropriate for you. |
A close company (which generally includes owner managed companies) is taxed in certain circumstances when it has made a loan or advance to individuals or their family members who have an interest or shares in the company (known as participators). The tax charge is currently 33.75% of the loan if it is outstanding nine months after the end of the accounting period. The tax charge is repaid to the company nine months after the end of the accounting period in which the loan is repaid.
Further rules prevent the avoidance of the charge by repaying the loan before the nine month date and then effectively withdrawing the same money shortly afterwards.
A ‘30 day rule’ applies if at least £5,000 is repaid to the company and within 30 days new loans or advances of at least £5,000 are made to the shareholder. The old loan is effectively treated as if it has not been repaid. A further rule stops the tax charge being avoided by waiting 31 days before the company advances further funds to the shareholder. This is a complex area so please do get in touch if this is an issue for you and your company.
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Planning Tip |
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Ensure that sufficient salary and dividends are drawn from the business to prevent these charges arising unnecessarily on an overdrawn director’s current account. We can also ensure that overdrawn accounts are cleared properly. Please contact us if you would like to discuss the right options for you and your business. |
The profits of a limited company are calculated in a similar way as for unincorporated businesses and the same rules with regard to expenses and capital allowances generally apply. Remember though that the salaries paid to directors, but not the dividends paid to shareholders, are deductible from the profits before they are taxed.
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Tax Planning |
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Companies are a popular business structure as they generally result in less tax being paid overall. However the tax rates on dividends (8.75%, 33.75% and 39.35% depending on whether you are a basic, higher rate or additional rate taxpayer) and the Dividend Allowance assesses the first £1,000 of dividends at 0%. Tax and NIC savings available by incorporating and trading as a limited company. We would be happy to discuss the implications of incorporation with you before you decide whether or not to incorporate your business. |
Corporation tax is usually payable nine months and one day after the year end, so the choice of accounting date has no tax consequence.
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Practical Tip |
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HMRC issue toolkits on various tax topics to help taxpayers and their agents comply with tax law. One of the main areas of non compliance identified by HMRC is poor record keeping and this applies to all types of business. If you would like guidance on what records to keep please get in touch. |
Over recent years, many families have been attracted by the savings that can be made by combining small salaries and large dividends. It was possible to increase the savings available by introducing a non-working family member into the business as a shareholder or co-owner, to use up their personal allowance and lower rates of tax.
Care needs to be taken as rules aimed at counteracting this in the ‘settlements legislation’ could be used to challenge certain arrangements. If you have any questions or concerns, please do not hesitate to contact us.