When starting or restructuring a business in the UK, one of the most critical decisions you will make is choosing the right business structure. The two most common options are partnerships and limited companies, each with its own set of benefits, tax implications, and legal differences.
In this article, we will explore the key aspects of both structures to help you make an informed decision.
What are the ways you can set up a business in the UK?
There are 3 main types of trading:
Sole Trader – This is 1 person trading in business alone as self-employed
Partnership – This is 2 or more people trading in business together
Limited Company – Either a Sole Trader or a Partnership can decide to trade as a Limited Company.
What are the differences between a Partnership and a Limited Company?
The way the business is owned:
A Partnership is owned by the Partners. You can own different percentage levels, e.g. 50/50 or 70/30 etc. It is recommended that a Partnership agreement is drawn up stating the percentage of ownership per Partner as soon as a Partnership is agreed. A Partnership can be set up by informing HMRC.
A Limited Company has shares and each owner is called a Share Holder. Each Share Holder has a certain number of shares. A Limited Company must be created at Companies House as well as HMRC being informed.
The liability of each owner:
As a Partnership, there might be 2 or more Partners, but the business and the owners are seen as I entity in the eyes of the law. If the Partnership owes money to suppliers and can not pay that money through the business, the owners have to pay the suppliers through their own personal finances.
A Limited Company is seen as a separate entity to its Directors and Shareholders. This means if the company owes a supplier money, it is only the company that owes the money to the supplier and as long as the Directors have managed the company correctly, there would be no reason where a supplier could target the personal belongings of a Shareholder to clear a bill that is owed by the company.
How money can be taken out of the business by the owners:
As a Partnership, there is no protection for the individual Partners against business liability as mentioned above. Because of this Partners will take money out of the business as drawings. If the Partners took more money out than the available profit, there would be no tax implications on the Partners. If enough money is not left in the business to clear the business debts, the Partners themselves are personally liable to pay the debt.
A Limited Company means the Shareholders personal belongings are protected against debts of the business because there is Limited Liability. To offset this there is also much more legislation on how a Shareholder can take money out of the business. A Director/Shareholder can take a wage through the company using PAYE just like any other employee. After wage, any other money withdrawn must be covered by available profits after tax has been deducted. If the Director/Shareholder took out more money from the business than was available, this is called an overdrawn Directors Loan Account.
Benefits of a Limited Company in the UK
Limited company benefits include limited liability, which protects your personal assets in case the business incurs debts. Additionally, limited companies can raise capital more easily through the sale of shares and enjoy corporate tax rates, which are generally lower than income tax rates.
However, there are also administrative burdens, such as filing annual accounts with Companies House and maintaining a formal board of directors.
Advantages of a Partnership in the UK
A partnership, on the other hand, is simpler to set up and maintain, with fewer administrative requirements. Partners share the profits and losses of the business, and there is more flexibility in decision-making.
However, partners have unlimited liability, meaning their personal assets are at risk if the business incurs debts. Partnerships also face tax implications, as partners are taxed on their share of the profits.
Administrative Requirements
Partnerships
Annual Self Assessment tax returns for each partner
Partnership tax return (SA800)
Maintain accurate financial records for at least 5 years
Register for VAT if turnover exceeds £85,000
No requirement to file accounts with Companies House
Limited Companies
Annual accounts filed with Companies House
Annual Corporation Tax return (CT600)
Confirmation Statement filed annually
Directors' Self Assessment tax returns
PAYE and NICs if employing staff
VAT registration if turnover exceeds £85,000
Maintain financial records for at least 6 years
Converting Between Structures
Partnership to Limited Company
Form a new limited company
Transfer partnership assets to the company (consider capital gains implications)
Issue shares to partners based on their partnership interests
Notify HMRC of the change in structure
Register the company for Corporation Tax
Consider stamp duty on property transfers
Limited Company to Partnership
Form a new partnership agreement
Transfer company assets to partners (consider capital gains and income tax implications)
Dissolve the limited company following proper procedures
Notify HMRC of the change
Register the partnership with HMRC
File final accounts and tax returns for the company
When converting, it's crucial to consider:
Potential tax liabilities arising from the transfer of assets
Impact on existing contracts and business relationships
Changes in personal liability
Costs associated with the conversion process
What happens if you take too much money out of a Limited Company so have an overdrawn Directors Loan Account?
You have 9 months and 1 day to pay the overdrawn amount back to the company.
If the overdrawn amount is not paid back in time you will need to pay tax on the overdrawn amount.
HMRC will refund the tax once the overdrawn amount has been repaid to the company.
What are the differences in tax calculations between a Partnership and a Limited Company?
Partnership
Income Tax:
Each partner can earn an amount of income, tax- free. This amount is set every tax year.
Income Tax Rates:
Profit is taxed at different percentage rates depending on the amount of income and the tax rates of the year.
National Insurance:
Each Partner must pay National Insurance on a level of profit depending on the year
Limited Company
Corporation Tax:
There is no tax-free income allowed in a Limited Company. We recommend running a Directors Wage which would then allow the Director/Shareholders to take out the maximum amount before Tax & NI is charged.
Corporation Tax Rates:
Profit is taxed at a percentage rate depending on the year, but the rates are not the same as income tax rates.
Dividend Tax:
There is no National Insurance to pay, but there is Dividend Tax to pay.
Tax Implications of Limited Companies vs Partnerships
The tax implications of limited companies and partnerships differ significantly. Limited companies are subject to corporate tax on their profits, while shareholders are taxed on dividends received. In contrast, partnerships are not taxed as entities; instead, partners are taxed on their individual share of the profits.
Legal Differences Between Partnerships and Limited Companies
Legally, limited companies are separate entities from their owners, providing a clear distinction between personal and business assets. Partnerships, however, do not have this separation, and partners are personally liable for the business's debts. Understanding these legal differences is crucial for making the right choice for your UK business.
What are your next steps?
It is important to consider:
What is more important to you, flexibility over drawing money, or protection over personal assets? Flexibility over drawings means you would be more suited to being a Partnership. Protection over personal assets means you are more suited to setting up as a Limited Company.
What are your future goals for the business? Share this with us and we can help you decide your best options.
At what income level will it be more tax- efficient to go from a Partnership to a Limited Company? We can help with calculations that will help guide your decision.
Share your goals with us, and we will:
Explain your options further, complete any calculations to show when tax efficiency kicks in, book a free consultation today and help light the way for your next steps.