We solve your legal problems. Read our legal advice guides & instruct the best lawyer for you.
Starting a new business can seem daunting. The choices you make largely depend on the type of business you want to run. For example, the direction taken by a sole trader is likely to be different from that of a limited liability partnership as they have different tax responsibilities and legal requirements.
This guide covers the main models used in business today: sole trader, partnership, limited liability partnership and a private company limited by shares. It also provides information on what each of the terms mean, how to begin using the business structures, and the tax liabilities, accounting and disclosure requirements of each model.
When starting a business, you need to choose a business structure. The business structure determines your legal responsibilities at the start and during the functioning of the business, including:
A sole trader is responsible for running his or her business and for meeting the legal requirements that come with it. As a sole trader, you can keep all of your profits after tax; however, you are also personally responsible for any debts of your business. Debts of the business include any losses the business makes, anything bought for the business (such as stock and equipment) and also any wages owed to staff. Even though you are a ‘sole’ trader this does not mean you cannot take on any staff - you can have staff as part of your business but they will not be held responsible for any legal requirements.
A sole trader is considered to be ‘self-employed’. This means you must register with HM Revenue & Customs (HMRC) for self-assessment as soon as possible after starting your business.
If you are a sole trader, you need to pay income tax and National Insurance, called Class 4 National Insurance, on your business’s profits. Unless your profits are very low, you also have to pay Class 2 National Insurance.
All these taxes must be paid each year by 31st January following the end of the tax year (5th April) or you risk incurring penalties from HMRC.
Once you have registered for self-assessment you will usually receive a letter in April or May from HMRC telling you to send a tax return. You should always send your tax return, even if you do not have any tax to pay.
You can submit your tax return online or through a paper application. However, deadlines for paper applications are much earlier than that of online applications. If you miss the deadline for a paper application, you should submit your return online.
A sole trader business is simple to set up legally, although certain trades may need a license. These include nightclubs, taxi and car hire, restaurants, pet shops, indoor sports venues, adult shops, street trading, hotels, pet kennels, nursing homes, waste management, weapon sales and money lending. A license can be obtained from the relevant local authority.
To make sure your business is operating legally you should consult relevant legislation, for example:
You should also look into any relevant legislation relating to environmental and health and safety requirements. Also check the planning and building regulations relating to your premises.
In the situation of insolvency, a sole trader is personally liable for any debts (liabilities) owed both personally and by his or her sole trading business. Business creditors can seek personal assets as well as business assets to repay the debt owed. Similarly, personal creditors can pursue business assets of a sole trader to repay a debt owed by a sole trader.
The Partnership Act 1980 defines the word ‘partnership’ as "the relation which subsists between persons carrying on a business in common with a view of profit”. This excludes any entity which has been incorporated and regarded as a company.
If you set up a business with a friend and intend to make it a profitable business then you are involved in a partnership, and partnership law applies. This is true even if there is no written partnership agreement.
However, if you belong to a non-profit seeking club, such as a small local football club or community organisation, that does not intend to be profit making, then this is classed as an association and not a partnership
Although it is easier to set up a partnership than most other business models, there are still a few legal requirements to be met. It is recommended to draw up a partnership agreement to protect yourself in case of an unresolvable dispute or dissolution of the partnership business.
You must have a ‘nominated partner’. The nominated partner needs to register the partnership with HMRC. This person will automatically register personally for self-assessment when he or she does this.
In a business partnership, you are running a business as a self-employed individual but all the partners share responsibility for the business. You can share all the profits between the partners and each partner pays tax on his or her share of the profits.
The nominated partner must keep business records and manage and send the partnership’s tax return. The taxes which apply to a partnership are the same as that of a sole trader (described above) except that the liability for tax is shared between the partners.
The nominated partner must also register the partnership and themselves for self-assessment. The other partners register separately (they usually do this after the partnership is registered).
Both the nominated partner and individual partners are responsible for:
You are personally responsible for your share of:
If you do not want to be personally responsible for the losses of a business, you can set up a limited partnership or limited liability partnership, described below.
A partner does not have to be an actual person. For example, a limited company counts as a ‘legal person’ and can also be a partner in a partnership.
A partnership is set up using the funds of the partners. Partners then share the liability (depending on the partnership type), the profits and the responsibility for how the business is run. In the situation of insolvency, partners are personally liable for any debts (liabilities) owed both personally and by their partnership. Business creditors can seek personal assets as well as business assets to repay the debt. Similarly, personal creditors can pursue business assets of a partnership to repay a debt owed by an individual who is a partner.
Although given the “partnership” label, a Limited Liability Partnership (LLP) is in fact a body corporate. This means it is similar to limited companies to the extent that it has a legal personality separate from its members, with no restrictions on the kind of business it can transact. Importantly, separate personality means that it is the LLP, and not its members, which will be liable to third parties.
Two or more people need to subscribe their names to an incorporation document. Although there is no set format, a solicitor, accountant or formation agent should be contacted to ensure the document satisfies all the requirements, which includes a declaration of compliance and the following information:
The incorporation document can be simply a standard partnership agreement modified for the purpose. Most LLPs prefer a detailed agreement to protect members’ interests and in order to replace certain terms implied by law.
Members of an LLP are the people who subscribe their names to its incorporation document. A member joins an LLP by agreement with existing members. There is no particular form to complete. In the absence of a specific agreement, a member may exit an LLP by giving reasonable notice to the other partners. Members are not considered to be employed by an LLP unless they would be regarded as salaried partners in a normal partnership.
An LLP is treated as a partnership for capital gains tax and income tax purposes, despite being a body corporate.
Relief is provided from stamp duty on transfers of property to a newly incorporated LLP, to aid the transfer from an unincorporated partnership to an LLP.
Members are treated similarly to self-employed people.
Although an LLP is treated as a partnership for most tax purposes, it is subject to much of the law relating to companies and insolvency. As such, LLPs need to submit annual returns, appoint auditors, prepare and file accounts and comply with accounting standards.
Members in an LLP are protected by the concept of limited liability that is applied to bodies corporate. A member’s liability is limited to what he or she has invested in the company and no more. A member’s personal assets cannot be sought by creditors unless that partner has given a personal guarantee to a creditor.
A private company is one which is incorporated and limited by shares. This means that the company has shareholders and the liability of the shareholders to creditors of the company is limited to any money they originally invested. A shareholder's personal assets are protected in the event of the company's insolvency, but money invested in the company will be lost.
The company is run by directors rather than the shareholders themselves, although shareholders may also be directors.
All limited companies must pay an application fee and be registered (incorporated) with Companies House. To do this, you need:
You can register your company online but only if the company is limited by shares and uses the model articles of association. Alternatively, you can register by post - you must do this if you change the model articles or use your own drafted articles.
You can also use an agent such as a solicitor to incorporate the company for you.
A limited company must pay corporation tax on its profits for each year it trades. This tax has to be paid to HMRC by nine months and a day after the end of the financial year. So, if your company prepares accounts to 31st March each year, then any corporation tax is due by 1st January the following year.
The company must also file a form called a ‘corporation tax return’ to HMRC each year, showing how its tax was worked out. Usually, your accountant files this for you, or you can use HMRC’s free software to create and file your return.
The corporation tax return is not due until 12 months after the end of the financial year, although most companies do not wait as long because their corporation tax is due three months before this.
Running your business through a limited company can result in you paying less tax than if your business is a sole trade, but there are a lot of extra considerations to make. If you have any doubt, ask a solicitor for advice.
Choosing to run your business as a company gives you the benefit of limited liability. However, companies are subject to more rules compared to other business entities. This is a summary of some of the main requirements, although it is not an exhaustive list.
Directors: When you register your company it must have at least one director. A director is legally responsible for the running of the company. A director must be older than 16 and not be someone disqualified from being a director. Directors have certain duties which they must abide by which are outlined in the Companies Act 2006.
Statement of Capital: When you register a company you need to make a ‘statement of capital’. This is:
Articles of Association: When you register your company you must have articles of association.
These are the rules about running the company that shareholders and directors must agree to. Most companies use the model articles but this is not necessary and you may use articles that have been drafted specifically for your company.
Change of Information: You must tell Companies House if you want to change your company’s registered office address. If the change is approved, they will tell HMRC. Your company’s new registered office address must be in the same part of the UK that the company was registered (incorporated).
You must tell Companies House within 14 days if you make changes to:
You must tell Companies House within a month if you issue more shares in your company.
Shareholder Decisions: You may need to get shareholders to vote on a decision if you want to:
This is known as ‘passing a resolution’. Most resolutions need a majority to agree (called an ‘ordinary resolution’). Some might require a 75% majority (called a ‘special resolution’).
Record Keeping: You must keep details of:
Accounts: You must keep accounting records that include:
You must also keep any other financial records, information and calculations you need to complete your company tax return.
Companies House Annual Return: You must send Companies House a company annual return and processing fee every year, within 28 days of the anniversary of the company’s incorporation. You can send the company annual return either online or by post.
Owners of a company benefit from limited liability. This is because the company has its own legal personality and becomes its own legal entity. Ownership of that legal entity is divided into shares, with each shareholder purchasing shares in the company and, as a result, investing in the company. The shareholders and the company are different legal persons. This creates the doctrine of limited liability. Limited liability means that the shareholders’ liabilities are limited to what they have invested in a company. Creditors may only seek the company’s assets for repayment of a debt and the shareholders’ personal assets are protected.
Nothing in this guide is intended to constitute legal advice and you are strongly advised to seek independent advice on matters that affect you.