NOTE: Updated for the 2021/2022 Tax Year
This is not legal advice, it’s just what we have learned through our experiences. If you are not in the UK, the rules and figures will be different, so please do your own research before jumping in.
If you have concerns or questions, please contact HMRC or consult professional advice.
When you start a business, you will have to decide which is the right legal structure for setting yourself up.
There are various ways depending on what you want to achieve and how you want things to run.
When setting up, have a little think about which structure best suits you and the way you want to do business.
The two most popular options are either to set up as a Sole Trader or as a Limited Company (Ltd).
Many people choose to be ‘Limited’ because they think they need to be in order to be a ‘proper’ business. They do this without even thinking about the extra paperwork, Companies House returns or tax implications.There are some things to consider when deciding which business structure to use.
Here are some things which will be affected by your choice:
- Level of liability involved
- Tax and National Insurance payments
- Who you’ll need to notify that your business exists
- Records and accounts that you will have to keep
- The ways your business can generate money or raise funds
This can be a lot to think about and probably doesn’t make it any easier to work out which business model is right for you.
So here are some alternative things to consider when deciding which business structure to use:
- Will you be working alone or with others?
- Is your aim to run a successful small business or build a massive company?
- Would you enjoy long meetings with HMRC?
- Do you like filling in forms, completing paperwork, and doing administration?
- Do you enjoy fundraising?
- Do you like making your own decisions or working as part of a team?
Business Structures
Here are some common business structures to consider and some information about each:
SOLE TRADER / SELF-EMPLOYED
This is the simplest business structure.
- There are no fees to be paid upon set-up.
- The paperwork involved is minimal. You must keep records showing your business income and expenses.
- You keep any profits you make, as you are the business.
- All decisions on how the business is run are made by you.
- Your profits are taxed as income (this means you still have a personal allowance like a person who is employed).
- You must also pay National Insurance contributions on profit.
- You must register for (Tax) self-assessment with HMRC and complete an annual tax return form.
It is worth noting that as a sole trader, if your business runs up debts, you are personally responsible for this and will be held accountable. This could put your home or other personal assets at risk, which is why we are showing you how to get started without accruing debts or borrowing money. If you aren’t going to borrow any money, then this will not affect you at all.
DON’T BORROW MONEY! Make money through sales.
By far the easiest business structure to begin with is to be a sole trader. With less paperwork and administration involved than every other structure, the only negative of setting up like this is the fact that you are personally responsible for any debts in your business.
LIMITED COMPANY
To set up as a limited company, you have to register with Companies House.
- You will need to fill in paperwork which includes your company name, the address for the company, the details of at least one director and one shareholder.
- You will receive four pieces of paperwork back:
- ‘Memorandum of Association’ – this is an agreement between the initial shareholders to create the company.
- ‘Statement of Capital’ – this is the detail of the company shares and the rights attached to them.
- ‘Articles of Association’ – these are the rules for how the company will be run.
- ‘Certificate of Incorporation’ – this shows the company number and date it was set up and confirms that the company legally exists.
- This is the way to set up if one or more people are working together in partnership.
- You will have to register for Corporation Tax.
- The reason it is called a ‘limited’ company is because, in the event of failure, liabilities are limited to the company (it’s assets and worth), instead of being the personal responsibility of the people involved.
There are reasons for setting up in this way and it will be a decision that you will have to take as a business owner, but as you can see – the more complicated the structure of your business becomes, the more paperwork and administration will be involved.
We frown upon anything that takes your energy and focus away from the core thrust of your business, which at all times should be promoting what you do and selling your value.
Simon likes less time on paperwork and
more time doing fun stuff
(like selling or doing what you love to do).
Be like Simon.
PARTNERSHIP
The power of any business partnership is in finding the right people to collaborate with.
- To set up a business partnership, you must choose a name for the business. You can use your own name or trade under a business name.
- You must also choose a ‘nominated’ partner, who will be responsible for managing the tax returns and keeping necessary business records.
- You must register with HMRC.
- Be aware that there are different rules for limited companies and partnerships.
- You must include the names of all partners and the business name on all official paperwork, including any invoices and letters that you send out.
COMMUNITY INTEREST COMPANY
Put simply, a Community Interest Company is similar to a Limited Company, but trades with a social purpose or community benefit, rather than private profits.
- Assets are kept within the company to support its social activities and benefit the community.
- Profits taken from the company as dividends are subject to a lock (you can’t take all the profit – a minimum of 40% needs to be invested in a social purpose).
- Community Interest Companies are set up (like Limited Companies) via Companies House and involves similar paperwork, with an emphasis on the intentions of each person involved and the mission of the company.
- There will be a test to determine if the company exists for the community interest. This test will look at the range of activities that the company will engage in and who benefits from these activities.
SOCIAL ENTERPRISE
A Social Enterprise is a business that trades with a social or environmental purpose at its core.
- This type of company carries out activities for the benefit of the community rather than purely for private profits.
- You may describe yourself as a social enterprise if you:
- Are interested in providing activities that benefit the community.
- Will provide those activities by using the proceeds of selling and generating income from sales.
- Make sure that the lion’s share of profits or company assets are used for purely social purposes
RED HERRING ALERT
Social Enterprise is not a legal structure, it’s a type of business model.
You can operate as a social enterprise whilst being a sole trader or having a limited company.
CHARITY
A charity is a slightly different type of business entity in that it enjoys some perks that other businesses don’t:
- Tax relief from HMRC
- Preferred rates when running an advertising campaign (charities don’t pay VAT)
- Public recognition as an organisation designed to do good things.
There are six steps to setting up as a charity:
- You will have to find at least three people who will act as trustees for the charity. Each are responsible for an aspect of the business.
- Prove that the organisation has a purpose that is for public benefit with a charitable endeavour at its core.
- Choose a name for your charity
- Choose a business structure for your charity – this is the who, what, when, where, why, how of the business.
- Create a ‘Governing Document’. This is the nuts and bolts of the business and lets people know, what your charity does, who runs it, the purpose for its existence, and so on.
- You must register as a charity. This gives you a business number and makes you a recognised charity, allowing you to receive the benefits listed above.
How do you decide which Business Model suits your business?
The main thing to work out is how much you like filling out forms and completing paperwork. Even if this isn’t something that bothers you in the slightest, we hope by now that you would prefer to do as little of this as possible, as it takes away from your main focus of ‘making money doing what you love’.
Needless to say that the more basic the business structure, the less paperwork and form-filling will be involved.
As always, here at the Rebel Business School, when getting started, and wanting to get up and running as quickly as possible, we advise keeping it simple.
How do you keep it simple?
Managing Your Accounts
The financial accounts are something that every company, no matter how big or small, have to keep. This helps with filling in tax returns and understanding the financial aspects of your business such as cash flow, profit and loss and expenses.
To put it in its simplest terms, a business should keep records of all money that is spent and all money that is earnt. The difference between these two figures is your profit (or your loss). The trick is to make sure at all times that the money earnt figure remains higher than the money spent figure.
That is why here at Rebel we recommend starting your business without incurring any debts and making money as soon as you can.
One major benefit of doing this is so that, if accounts and paperwork isn’t your thing, you can afford to pay someone else to do it.
Entrepreneurship isn’t about doing everything by yourself, it is about finding people who are good at something, who you can work well with and start working together.
You should focus on making money as soon as possible so that you can tackle all the other problems you will have, in style.
Tax and VAT
Tax and VAT are two things that will become necessary to know about when you start your own business. When you are an employee, whoever you work for kindly removes your tax before you receive your wages, but this isn’t the case when you run your own business. VAT isn’t even a concern when you are an employee.
The best thing to do when you start earning money for yourself is to allow for tax in all that you earn. So, for every £10 that you make, you should consider that you have made £7 and put the other £3 away to cover your tax and national insurance contributions. If you get into the habit of doing this then you won’t receive any nasty surprises when the taxman comes calling.
As a sole trader, you have three months from the date that you start trading to inform HMRC that you are in business.
What happens if you don’t inform HMRC?
The simple answer is that at some point they will find out. Either the job centre will advise them when you stop claiming benefits, or your past employer will inform them that you have left the company. It is better to call and let them know that you have started a business, when the time comes. The optimum time to do this is when your business starts to generate revenue.
As a sole trader you will still pay tax as if you were employed and as such, are entitled to the same personal allowance.
As of 2021, the tax-free personal allowance is £12,570.
You can find out more about your personal allowance here.
It may be that you run an online business and trade with people who are not based in the UK, therefore, you may be confused as to how HMRC would be aware that you were in business and generating income.
The best advice we have been given when asking the question on whether a location-independent, online business trading with non-UK customers can avoid paying tax was simply a question asked to us in return:
“Do you like sleeping at night?”
You see, there is no point in trying to avoid paying tax, and here at Rebel Business School, we don’t recommend it. We think you should set everything up simply and properly from the start so that you can live a stress-free life. You don’t want to embrace a new life of freedom, passion, positivity, motivation and progress, only to spend your time constantly worrying about HMRC (or anything else for that matter).
Everything we advise is designed to make the process of getting started as easy as possible, so when that first invoice comes in, let HMRC know that you are trading. Then, if you pay someone to look after your tax returns, you may never have to speak directly to them again.
We always say, let the other guy be the one who is stressed and keep yourself right at all times. Especially those few times in the year when you have to communicate with ‘the system’.
Paying tax is a good thing. Why? Because it means you’ve made a profit.
An idea that you make no progress on will never be anything more than an idea.
An idea that you make progress on will turn into a business.
NOTE: This article has been updated for the 2021/2022 UK Tax Year.
If you have concerns or questions, please visit the HMRC website or consult professional advice. This is not legal advice, it’s just what we have learned through our experiences. If you are not in the UK, the rules and figures will be different, so please do your own research before jumping in.
Further reading: