If you are considering trading in the UK you need to consider whether to trade as a sole trader, limited company or a partnership. A lot will depend on a number of potential influencers such as:
- How much you think the turnover will be in the first twelve months
- Whether you are you going into business with someone else?
- How your trading partners will want you to trade (some will deal with you if you are limited)
- Whether you obtain professional advice at the outset
- How much risk you are prepared to take with your business
Sole Trader (Self Employed)
You must let HMRC know that you are intending to become self-employed as soon as is practical to do so. Your tax year will run from April 6th to April 5th the following year and this is known as self-assessment. You won’t need to have your accounts sent to HMRC but you will definitely need to keep receipts and proper records for your accountant so they complete your tax assessment on your behalf and have proof if required. You must keep this ‘evidence’ and relevant documents for at least 5 years so as s rule of thumb – if in doubt keep it filed I a secure place.
Your income tax bill must be paid by the following January 31st and if you don’t pay on time you can be fined so be aware. There may be other taxes to be paid such as CIS, VAT and there will be National Insurance Contributions so you must seek professional accountancy advice to help get this set up correctly.
Being a sole trader means you are responsible personally for your business debts so this is something to be considered seriously when making the decision of how to trade. In plain English if you have £50,000 of business debts 2 years down the line then this £50,000 will be considered a personal debt not a business debt. This situation may not mean anything if the business is trading well but when things go wrong this can be disastrous for the family unit. For example if HMRC are owed taxes and these cannot be paid and you own your own home then this asset can be at risk if the tax is sufficient to warrant HMRC to force bankruptcy.
You can always change your mind of course as your business grows and you can become a limited company at a later date and this is not unusual, though there may be tax consequences of doing so and your accountant should always be consulted.
Many sole traders get themselves into difficulty simply because they didn’t realise they should keep a separate bank account for business matters to simplify matters for your accountant when getting ready for your tax assessments. It is one of the most basic tasks to be completed but is often overlooked which can make makes such as differentiating between business income and expenditure matters extremely difficult.
A Limited company is a separate entity in its own right so any business liabilities belong to it not the director unless personal guarantees have been signed. The company must have its own rules and they are called the Memorandum & Articles of Association and they basically outline what the company can and cannot do and the way it must operate. The company must have at least one director and often has a company secretary who is usually responsible for the financial aspects but this is not a requirement now. For smaller companies the shareholders and the directors are usually the same but not necessarily so. Directors are ‘officers’ of the company and are usually employed by the company and they have a legal responsibility to act in the best interests of the company and shareholders. If you do not act in the best interests of the company and the company does become insolvent then the directors may be pursued personally for the company debts.
Typically a company becomes insolvent when it can no longer pay its bills and this is called the cash-flow test and or the debts may be greater than its assets and this is called a balance sheet test. Either way as a director you have a responsibility to know if your company is insolvent and generally you should cease trading if the company is insolvent. If you do try to trade your way out matters when there is no real prospect of success whilst insolvent you should always seek professional help as it can be a legal minefield for directors.
For example did you know simply taking a salary when creditors are left at a disadvantage may have serious consequences for the director. Something that may seem completely logical and fair to you may not be in the eyes of the law.
Tax is paid differently and is called corporation tax and is based on your accounts which are called the annual returns which must be made to Companies House each year and failure to do so can lead to you being fined.
As a director you also have a legal responsibility to ensure you keep good company records, general tax information and even making sure invoices are addressed correctly as you may be made personally liable. Be aware ignorance of company law is not accepted as a defence when dealing with the law and especially HMRC so selecting the correct accountant may be critical to the success of the business.
Image courtesy of renjith krishnan / FreeDigitalPhotos.net
Written by: Mike Smith