Most small businesses operate in one of the three following forms :
Put simply this means that you trade under your own name. It means that any liabilities, including tax, are your sole responsibility.
From a tax point of view you pay the appropriate tax depending on the tax band your income falls into. You also pay Class 4 National Insurance.
There is one significant disadvantage to trading as a sole trader or partnership. If your income is at a certain level, each 31 January you not only have to pay the current tax you owe, less any tax payments on account paid in the previous tax year, you also have to pay tax payments on account for the following tax year, in two equal parts, due on 31 January and 31 July. This can significantly affect your cash flow position.
This means that two or more persons trade together under a collective name. The partners are jointly and individually liable for any liabilities, including tax, relating to the partnership.
From a tax point of view you as a partner pay the appropriate tax attracted by the tax band(s) your share of the partnership income falls into. You also pay Class 4 National Insurance. There can be savings on Class 4 National Insurance operating as a partnership as opposed to a sole trader.
There is also the significant disadvantage to trading as a partnership as to that of a sole trader. If your income is at a certain level, each 31 January you not only have to pay the current tax you owe, less any tax payments on account paid in the previous tax year, you also have to pay tax payments on account for the following tax year, in two equal parts, due on 31 January and 31 July. This can significantly affect your cash flow position.
This is a legal entity formed for trading purposes. The founders of the company invest money into the business in exchange for shares. The liability of the company founders is restricted to the amount unpaid on these shares – the limited of the title.
This limited liability has led to abuses in the past where companies have generated debts and been unable to pay them and only been liable to pay the unpaid amount on their shares. In practice now, banks secure loans and overdrafts by obtaining a personal director’s guarantee. But it does still offer a degree of financial security to the owner(s).
There are a number of requirements that have to be followed with this method of trading such as filing accounts and annual returns with Companies House. There are restrictions about how you take out money from a limited company i.e. Director’s salary and dividends. Because of the need to comply with company legislation, accounts are more complex to produce and so cost more than other trading methods.
From a tax point of view, above a certain trading profit, there can be a distinct advantage to trading as a limited company. Tax on company profits is currently 20%, this can be a lot less than the levels of tax and national insurance generated by sole traders and partnerships. The system of payments on account, so hated by taxpayers operating through other trading methods, does not apply to limited companies.
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