BUSINESS STRUCTURE – IT’S NOT ALL ABOUT TAX
From that moment you get your first idea that just won’t go away to deciding that this is it, this is your passion and what you want to do and then take the leap to do it there are lots of decisions that need to be made – some exciting and some rather dull. Business structure and set up probably (ok, definitely) falls under the latter but it is important to get it right as changing it later on can be a hassle you don’t really need or want.
Rather than looking at self employed versus limited company I am going to split this into the areas you ought to be considering when setting up:
· Client / customer base
· Financing needs
And yes, in that order too – basing key decisions solely around the tax implications isn’t always wise as circumstances change, business evolves and tax law changes. Where as your attitude to risk and the people you want to work with are less likely to.
Start by asking yourself what is your attitude to risk, what are the risks in your business?
If you are self employed then you and the business are one and the same, there is no legal distinction between the two. This means that if someone were to take legal action against your business then they are taking legal action against you and potentially your own assets are at risk.
If your business is a limited company then it is a separate legal entity and is deemed separate to you in the eyes of the law meaning if someone were to take legal action against your business it is the business and not you that they are pursuing and so it’s the assets of the business that are at risk and your personal liability should be limited to the investment you have made in your business (shares you hold, loans you have made etc). Although if you knowingly break the law or trade illegally as the director you can still be prosecuted (simplified, but you get the gist).
This is why knowing what your attitude to risk is coupled with knowing what the risks are in your business is important.
CLIENT / CUSTOMER BASE
When you start out a lot of businesses say yes to everything that comes their way, they want to get the name out there and get cash in. This is understandable but being a bit more discerning can save problems further down the line (a blog for another day). But, who are your ideal customers and clients, in a perfect world, who do you want to be working with and who will set your world on fire and make you excited to be working with? Once you know this you can consider the following:
Is your business structure key to being able to work with them? If you are wanting to work with the public sector / education etc then they often prefer to work with limited companies as they have an outdated notion that they are more official or more professional.
Do you want to give a certain image and perception to your potential clients? It might just be you at your kitchen table and that will excite some clients and customers, but others will want to know what the back up plan is, what if you are ill, how will the work get delivered? Knowing what the image is you want / need to give can help with knowing what structure you may need.
And these are just a couple of questions for starters! Thinking about this can help you determine whether to be self employed or set up as a limited company.
When you start out regardless of structure, you have no business history, no trading figures so raising finance is inherently more difficult and this means it is more likely that if you are looking for a loan they will look at your personal circumstances too to check you can afford to repay it and may look to secure it on your own assets.
As the business grows, you may still need cash injections and finance into the business. As above, if you are self employed the loan is yours and your ability to repay will be assessed along with the trading performance of your business. If you are a limited company, then the loan would be assessed on the company’s ability to repay it and the assets the business holds.
Other financing options may include third party investment and at this point they would want you to be a limited company so that there is a clear legal structure in place as to who owns what etc, as they will own part of the business and want a return on their investment via dividends as well as potential buy out in the future.
And last of all tax! As I said at the start, tax is part of the decision but shouldn’t be the driving force behind it all.
If you are self employed then your business profits (this is before any money that you take out of the business) are taxed via your self-assessment tax return and you pay Income Tax and National Insurance based on these profits and the amount of tax paid will depend on your profit levels as well as other personal income.
If you are employed then your profits are added onto your employment income and depending on the level of your salary could result in you paying tax at a higher rate.
If you are employed and you make a self employed loss, then the loss can be offset against your employment income and you can potentially get a tax refund.
If your only income is from self employment then it’s looking at the levels of profits you achieve to see if you would pay less tax as a limited company than when you are self employed. As a rough guide if your profits are around the £25k mark it’s time to have a chat with your accountant.
If you run as a limited company then you can pay yourself a mix of salary and dividends (presuming you have profits to pay dividends) so that your personal income is as tax efficient as possible as dividends are taxed at a lower rate. From the company point, it pays Corporation Tax on it’s profits and your salary is an allowable deduction to get to this profit figure, but dividends are not (so basically you would pay corporation tax on the dividends as well as being taxed personally .. but this can still be more tax efficient).
Tax is constantly changing (they like to keep me on my toes!) so if you have got through all the other decision factors and can’t work out what’s best for you talk to an accountant to get them to run some numbers to see what the difference would be for you.
Of course, this isn’t a complete and definitive list there may be requirements from professional bodies, trade bodies or insurers that need to be factored in. Or there may be the needs and wants of business partners to factor in too. Basically, it’s not always a straight forward decision!!