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Forming a Business
4. Sole Trader or Partnership
Most small businesses operate as sole traders. If two or more people go into business together, they may choose to trade as a partnership. Partnerships can be a good way of sharing management burdens and making sure people commit to the success of the business. But be aware of personal liability issues.
4.1 You are personally liable for all your business debts.
- There is no limit to the extent of your liability. If you cannot pay off your business debts, you can be made bankrupt.
- In a partnership, each partner is liable ‘jointly and severally’ for all the business debts of the partnership.This means that, if the business fails, you could end up having to pay your partners’ share of the debts, as well as your own. But for income tax purposes each partner is only liable for their own share of the profits.
4.2 You personally own the business assets.
- In a partnership, the assets are jointly owned, along the lines set out in the Partnership Agreement (see 4.5).
4.3 You pay income tax on any taxable profits.
- Your profits will be taxed at the appropriate personal rates.
- You pay tax on the profit, even if you have no actual drawings from the business.
4.4 Your National Insurance contributions (NICs) may be lower than if you are an employee of a limited company.
- A shareholder in a limited company may be able to take dividends without any NICs being payable.
- Ask your financial adviser whether your overall tax and NICs liability is likely to be lower if you are a sole trader (or partnership) or a limited company.
- There are restrictions on your entitlement to social security benefits.
4.5 In a partnership, it is normal to agree all your commitments at the outset in a Partnership Agreement.
- This critically important document covers matters like the money you put in and take out, holidays, adding (or removing) partners and how the business will be run.It is negotiated between the partners, often with the help of their professional advisers (see 7).
- A ‘sleeping partner’ is one whose involvement extends only to contributing capital and sharing in the profits.
4.6 You can limit your liability by setting up a limited liability partnership instead.
- This is a corporate body with its own legal identity and capacity. It must be registered at Companies House.
- It has the organisational flexibility of a partnership but offers limited liability to members.
- Members are self-employed and taxed in the same way as in an ordinary partnership.
- Annual accounts must be prepared and filed.There are other filing requirements, similar to those for a limited company (see 2).
- If you are a member of a trade association, check to see whether it has any conditions which may apply to your LLP registration.