Selecting a legal entity for your business

Selecting the entity of your business is very much dictated by the way you intend to work either on your own or in conjunction with others. Each entity has its own impact in the way you are protected under law and on the way you are affected by taxation rules and regulations. Each entity has its own pros and cons and is treated differently for legal and tax purposes.

Sole Trader/ Proprietorship

This is very much a business operated by one individual, or very often by a Husband or Wife. A Sole Trader/ Proprietorship is considered an extension of the individual who owns it and not a separate legal entity which the owner has the possession of the business assets and is therefore directly responsible for the debts and other liabilities incurred by the business. The profit or loss of a sole trader/ proprietorship is combined with the other income from the individual for income tax purposes. Other than the normal requirements of licences or permits this is the easiest form of business as is does not have any rules or operating regulations. Business decisions are solely the result of the owner's abilities.

Partnership

A partnership is the responsibility of two or more individuals who run the business jointly. Each Partner has a responsibility for the liabilities and ownership of the company assets. The way in which profits are shared and the authority of the partners is arranged through a Partnership Agreement. Partnerships are subject to what is called joint and several liability whereby the partnerships debts can be settled by way of the personal assets of each partner. The rights, responsibilities and obligations of the partners are detailed in a Partnership Agreement and it is recommended that an agreement is drafted for any partnership.

A partnership is a legal entity recognised under law. A partnership can sign contracts, obtain trade credit and borrow money. When a partnership is small most creditors require a personal guarantee of the partners for credit.

A partnership is also required to file an income tax return. A Partnership does not pay income tax; the information from the tax return is combined with the personal income of the partners to determine their overall tax liability.

Limited Company

A limited company has all of the legal rights, is a separate legal entity and is responsible for its own debts. Tax returns must be filed and the taxes paid are on income it derives from its operations. The shareholder and owners of a limited company are protected from the liabilities of the business. In other words provided the company is not knowingly trading insolvently the companies would the shareholders liability will be limited to losing their original investment if the company went bust. If the company is small often the legal protection afforded by the owners of a limited company can far outweigh the additional expense of starting and administering a limited company.

Approval from Companies House is to be sought to use its proposed name and the company must adopt and file a Memorandum and Articles of Association governing its rights and obligations to its shareholders, directors and officers.

A limited company must file annual Corporation Tax Returns with the Inland Revenue.

Company - Pros Company - Cons
Companies have greater borrowing potential.

Current assets can be used as security by way of a floating charge.

Shares are transferable if ownership changes but the business continues.

Can create impression of a soundly based organisation.

Limited Liability for shareholders.

 A company must be formally incorporated with a written constitution in the form of a Memorandum and Articles of Association, which would incur an initial set up cost.

Companies are ruled by the Companies Act, a company must:
  • Keep accounting records
  • In certain circumstances produce audited accounts
  • File accounts and an annual return with Companies House (this information is available to the public)
  • Keep statutory books

For more information, call us on 0113 274 3496 or email Clare Bruce at info@mitchellsgroup.com.

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