Tax Advice

How Your Business Structure Affects Your U.K. Taxes

There’s lots of new water to navigate when you start a business. You will love parts of it, but others will give you a major headache. Figuring out your business structure and how this affects your taxes can sometimes be the latter. Nobody wants to lie awake at night worrying they’re paying more tax than they need to or haven’t registered for corporation tax when they should have.

When it comes to business taxes, the trick is to know how much your business earns and spends. Your company’s business structure—sole trader, partnership, limited liability partnership (LLP), or limited company—will determine what taxes you pay and how much you’ll pay at tax time.

Our guide reflects the U.K. tax system, and you should treat it as general information. It’s no substitute for the advice of a tax or financial adviser who’s familiar with your specific circumstances. They’ll be able to help you when it comes to sorting out your taxes, business structure, and business profits.

What Are the 4 Types of U.K. Business Structure?

In the U.K., there are 4 kinds of business structures you need to be aware of:

1. Sole trader
2. Partnership
3. Limited liability partnership
4. Limited company

Let’s look at each of these individually, covering how they work, their pros and cons, and what each structure means for your business tax. For some, you’ll need to register with Companies House.

1. Sole Trader

Sole traders are considered to be self-employed. You’re responsible for running your own business and meeting the legal requirements that come with this. You can keep hold of the profits you earn after you’ve paid tax, but you’re personally responsible for any of your business’s debts. Sole traders can employ staff.

Rather than having your tax deducted by your employer, you’ll need to do this yourself by filing for self-assessment.

How It Affects Your Taxes

Sole traders pay income tax on their business’ profits. You’ll pay tax on any profit over the personal allowance of £12,570 as long as you’re not earning any other income, such as a salary from a permanent job. And how much tax you pay will depend on which rate your income is subject to.

There are 3 rates:

1. The basic rate of 20% (for income between £12,571–£50,270)
2. The higher rate of 40% (for income between £50,271–£125,140)
3. The additional rate of 45% (for income over £125,140)

There are different rates in Scotland.

Usually, you also pay 2 types of National Insurance when you’re self-employed. The amount you pay depends on how much profit you make.

• Nothing to pay on profits under £12,570
• £3.45 per week on profits over £12,570 (Class 2)
• 9% on profits between £12, 570 and £50,270 (Class 4)
• 2% on profits over £50,270 (Class 4)

Additionally, if you earn more than £85,000, you must register for value-added tax (VAT). You can register for this voluntarily if you earn less than £85,000 and want to claim VAT on your business purchases. You’ll have to submit VAT returns if you do.

Pros and Cons

The pros and cons of operating as a sole trader are as follows.

Pros

• Low running costs
• Easy to set up

Cons

• You’re entirely liable for your business’s debts

How to Register

If your turnover is over £1,000 from self-employment during the tax year, you must register for self-assessment by 5 October in your business’s second tax year. You don’t need to register with Companies House or pay corporation tax.

2. Partnership

A partnership is when 2 or more people share responsibility for their company’s management and profits. Each partner pays tax on their share of the profits. That said, a partner doesn’t have to be an actual person. It has to be a legal person, and this could be a limited company.

1 person needs to be a nominated partner. This person is responsible for managing the partnership’s tax returns and keeping records. You should have a partnership agreement document outlining the following:

• Liabilities
• Ownership
• How profits are split
• What happens when a partner leaves

All partners are responsible for any debts the business owes.

How It Affects Your Taxes

Each partner must register as self-employed, send their own self-assessment tax return, and pay any income tax and National Insurance contributions they owe to HMRC.

And just like being a sole trader, you’ll need to register for VAT if your partnership earns more than £85,000 (or voluntarily if you earn less than this but want to claim VAT on business purchases).

But there’s no need to register with Companies House or pay corporation tax when you’re in a partnership.

Pros and Cons

The pros and cons of registering your business as a partnership are as follows.

Pros

• Easy to form, manage, and run
• More potential to raise money

Cons

• Potential partnership disagreements
• All partners are liable for debt

How to Register

When you set up a business partnership, you’ll need to:

• Choose a name for your business
• Decide who the nominated partner will be
• Register your partnership with HMRC

3. Limited Liability Partnership (LLP)

In an LLP, unlike in a partnership, there’s no limit to the number of partners. But at least 2 of you have to be designated partners responsible for filing annual accounts.

Like a limited company, LLPs protect their members’ assets and limit liability for however much has been invested in the business. Plus, any personal guarantees that were given when raising loans.

How It Affects Your Taxes

Each member’s share of the profits is considered taxable income, like in a partnership. This means each member must register as self-employed, complete a self-assessment tax return, and pay income tax, National Insurance contributions, and VAT (if they earn over the threshold). LLPs don’t pay corporation tax.

Pros and Cons

The pros and cons of an LLP are as follows.

Pros

• Can be incorporated if the members’ agreement states this
• Benefits of both a partnership and a limited company

Cons

• Partners must disclose their income
• Must trade within 1 year of registering or be struck off

How to Register

Each member must register for self-assessment, and the LLP must be registered with Companies House. There should also be a members’ agreement stating how much profits each member receives.

4. Limited Company

A private limited company is incorporated and limited by shares. The company has shareholders, and the shareholders’ liability to creditors is limited to any money they originally invested. Shareholders’ personal assets are protected in the event of company insolvency, but money invested in the company may be lost.

Companies structured this way must have a director and a guarantor. You can take up both positions yourself, or multiple directors and guarantors can exist. You can also be a shareholder.

How It Affects Your Taxes

For the 2023–24 tax year, you’ll pay income tax on any dividends over £1,000 that you take from your business. The rates for this are dependent on your income tax band:

• 8.75% for the basic rate
• 33.75% for the higher rate
• 39.35% for the additional rate

This £1,000 dividend allowance is being reduced to £500 when the 2024–25 tax year begins.

Your limited company will also pay corporation tax on the profits it makes. For the 2023–24 tax year, the main rate for corporation tax is 25% for businesses with profits over £250,000. The Small Profits Rate of 19% applies to companies with profits under £50,000. If you have profits between these 2 markers, you may be eligible for Marginal Relief and charged corporation tax on a tapered scale.

Corporation tax is payable 9 months and 1 day after the end of your accounting year. So, if your year ends on 31 March, you’ll have to pay corporation tax by 1 January.

For this, you’ll need to complete a CT600 (company tax return) form no later than 12 months after your first accounting year.

And if you pay yourself a salary, you’ll need to deduct Class 1 employee contributions from this and pay these to HMRC. Your company will also have to pay Class 1 employer contributions at 13.8% unless the employment allowance covers this.

The current rates for Class 1 employer contributions are:

• 13.8% on pay over the secondary threshold of £758 per month

Lastly, you’ll need to pay VAT on profits over £85,000.

Pros and Cons

The pros and cons of a limited company business structure are as follows.

Pros

• Less personal financial exposure
• Limited liability protection

Cons

• Set up fees
• Accounts and financial reports must be in the public domain

How to Register

To register your business as a limited company, you must pay an application fee and become incorporated with Companies House. You’ll need information including:

• The name and registered address of the business
• At least 1 director
• At least 1 shareholder
• Company share details
• Articles of association (rules of how the company is run)

There’s No One-Size-Fits-All Business Structure

There’s no single correct answer for choosing a business structure. Different structures will work for different people in varying circumstances. You need to consider your financial situation and future goals to decide what business structure best suits your needs.

As we approach the end of the tax year, you have a great opportunity to consider which structure will work for you. Then you can begin the new tax year fresh with your new identity and correct information to file your tax return accordingly.

This post was updated in January 2024.