Creating a self-employed venture is an exciting time for many people in Droitwich. However, one of your most fundamental decisions is selecting the right business structure. Each structure has unique implications for tax, liability, and administrative responsibilities. This guide looks at the impact of tax and being self-employed and will help you understand the differences between being a sole trader, forming a partnership, and setting up a limited company. We will also delve into the necessary registrations for tax, National Insurance Contributions (NIC), VAT, and more.

Tax and being self-employed – the three main business structures

1. Sole trader: simplicity and control

As a sole trader, you are the individual owner of your business. This structure is popular among self-employed individuals due to its simplicity and ease of setup.

Advantages of being a sole trader:

• Full control: You have complete control over your business decisions and profits.
• Simple setup: Minimal paperwork and easy to establish.
• Tax benefits: You can offset business losses against other income.

Responsibilities and registrations:

• Tax registration: You must register with HMRC for Self Assessment. You must file a yearly tax return and pay income tax on your profits.
• National Insurance Contributions (NICs): You will have to register with HMRC for NICs. However, you may not have to pay Class 2 NICs, and Class 4 NICs only become payable if your profit is above £12,570.
• VAT registration: If your turnover exceeds £85,000 in a rolling 12-month period, you must register for VAT. This will require you to charge your customers VAT, but you can also claim back any VAT on purchases. You will also have to submit VAT returns.

Considerations:

• Liability: You are personally liable for any business debts.
• Growth limitations: Raising capital can be challenging, limiting business expansion.

2. Partnership: shared responsibility and resources

A partnership involves two or more people running a business together. It can be beneficial because it combines resources and expertise.

Advantages of a partnership:

• Shared expertise: Pooling skills and resources can enhance business capabilities.
• Shared liability: Partners share the responsibility for the business’s debts.
• Tax efficiency: Partners can benefit from tax reliefs on their shares of the profit.

Responsibilities and registrations:

• Tax registration: Each partner must register with HMRC for Self Assessment and file an annual tax return. The partnership itself must also file a partnership tax return.
• NICs: Partners may have to pay Class 2 NICs and Class 4 NICs based on their share of the profits.
• VAT registration: As with sole traders, you must register if the partnership turnover exceeds £85,000 in a rolling 12-month period.
• Partnership agreement: While not mandatory, a formal agreement outlining each partner’s responsibilities and profit share is advisable to have in place from the start of the partnership.

Considerations:

• Joint liability: Partners are jointly and severally liable for all the business debts.
• Decision making: Disputes can arise, making decision making challenging without an explicit agreement.

3. Limited company: separate legal entity

A limited company is a separate legal entity from its owners, thereby providing limited liability protection. This structure is more complex but offers significant advantages, especially for growing businesses.

Advantages of a limited company:

• Limited liability: The owners’ personal assets are protected from business debts.
• Tax benefits: Corporation tax rates are usually lower when compared to income tax rates.
• Salaries and dividends: In addition to receiving a salary from the business, you can also receive dividends, subject to their being sufficient retained profits in the company, which may be a more tax-efficient way of remuneration.
• Professional image: Clients and investors often perceive companies as more credible and professional.

Responsibilities and registrations:

• Company registration: You must register the company with Companies House, and upon doing so, you will receive a Certificate of Incorporation.
• Corporation tax: You will also need to register with HMRC for corporation tax, file annual company tax returns, and pay any tax that is due.
• Directors’ responsibilities: Directors must file annual accounts and confirmation statements with Companies House and adhere to their strict deadlines.
• NICs and PAYE: Directors are considered employees, so you must set up PAYE to pay salaries and NICs.
• VAT registration: As with a sole trader or partnership, you must register for VAT if the company turnover exceeds £85,000.
• Company Name: Ensure your company name is unique and complies with Companies House regulations.

Considerations:

• Administrative burden: Running a company involves more paperwork, and several compliance requirements must be met.
• Taxation complexity: Companies have more complex tax rules and there is the potential for double taxation from company profits and dividends.

Additional points to consider for self-employed people

This blog has primarily focused on the implications of tax and being self-employed. However, you may also find our ‘Business Start Up Checklist’ a helpful summary of other aspects of setting up and running a business, which you will need to take on board.

HMRC’s website provides more detailed information about tax and being self-employed. You can find this here: Self-employment: detailed information.

Conclusion

Choosing the right business structure as a self-employed worker is key to your success and compliance. Whether you are a sole trader, form a partnership, or establish a limited company, each option has distinct responsibilities, especially regarding tax and being self-employed.

Understanding the implications for tax registration, National Insurance Contributions, VAT, and other legal requirements will help you make an informed decision.

By assessing these factors, you can create a solid foundation for your business whilst being fully aware of the complexities of tax and being self-employed.

JRMA can advise you on the best structure for your business needs and how this will impact tax and other compliance matters. Please contact us at 01905 796512 or email info@jrma.co.uk to arrange a free consultation to discuss your self-employment options.