Types of Business Structures
There are three main types of business structure:
- Sole Trader
- Limited Company
1. Sole Trader
A sole trader's business is an extension of their personal affairs. It is easily set up with no legal formalities. A sole trader is personally responsible for all business liabilities. This means that, if the business ends with monies owed, creditors can sue the individual. The business accounts are confidential; the public cannot inspect them.
The sole trader will have to keep accounting records that may be inspected by the tax authorities from time to time. Accounts will have to be prepared on an annual basis, although the first set of accounts can be for a different length of time. These accounts will be used for completing the Tax Return and will normally be sent to the Inland Revenue for their inspection.
The sole trader will have to register for Value Added Tax (VAT) in most cases where the turnover goes above the limit specified by law. A Pay As You Earn (PAYE) scheme will need to be set up if employees are engaged. VAT and PAYE regulations are very complicated, and if not complied with correctly can result in heavy penalties. It may be helpful to have professional advice on their operation.
The sole trader pays income tax only on the profit made, not on monies withdrawn from the business.
A partnership arises where two or more persons run a business and share the profits in an agreed manner. It is advisable to have a partnership agreement drawn up by a solicitor in order that any disputes can be settled. Again, the partners will be personally responsible for all business liabilities and each may be responsible for the whole if other(s) default, not just their share of the liability. The only exception to this rule is with income tax liabilities. The business accounts are confidential; the public cannot inspect them.
Partnerships do not always work as the commitment of each partner may change over time, and unless this is reflected in the partnership profit-sharing arrangement it can cause disharmony. Friendship and business do not necessarily mix. However, when they do work they are an excellent way of running a business. The accounting records that are required are similar to a sole trader. Partners are taxed in a similar method to that of a sole trader.
3. Limited Company
A limited company is a legal entity established to separate the affairs of the business from the personal affairs of the owners. The liability of the owners is technically limited to the amount of their share capital invested. However, in practice, people will often require personal guarantees before lending money or supplying goods to the business.
A limited company can be purchased for a minimal cost but there are a lot of legal formalities to be complied with in running a company. Once a company has been formed, the initial shareholders will appoint directors to run the company. This will normally be the main owner(s). They will be paid a salary like any other employee. However, as a shareholder, they can also receive dividends. Corporation Tax is paid on the retained profits of the business, that is profit before dividends are paid.
Running a business through a limited company has certain advantages but involves much greater legal and accounting requirements. People mistakenly believe that because the name has the word 'limited' behind it, it is a large business and their money or goods are safe with them. This is not the case.
The accounting requirements of limited companies are prescribed by The Companies Acts and are more onerous than those of sole traders and partnerships. The statutory accounts have to be produced in accordance with The Companies Acts, which are very complicated. This means in practice that they will have to be prepared by a qualified accountant.
Limited companies will require an audit if their sales exceed a specified threshold. This will involve additional cost. Limited companies have to file accounts with the Registrar of Companies and these are available for public inspection. However, for most small companies it is possible to only disclose a lesser amount of information. If a company goes into liquidation, it is possible that the directors will have to meet the liabilities personally if they have acted fraudulently. Winding up a company can be expensive and is not straightforward.