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 assets of the business.

• In a partnership, the assets are jointly owned, along the lines set out in the Partnership Agreement (See 4.5).

4.3 You pay Schedule D 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.
• Ask your financial adviser whether your overall tax liability is likely to be lower if you are a sole trader (or partnership) or a limited company.

4.4 Your National Insurance contributions are generally lower than if you are an employee of a limited company.

But 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. Among other things, it should cover all the points in 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 in a partnership by setting up a limited liability partnership.

• This is a corporate body with its own legal identity and capacity.
• It has the organisational flexibility of a partnership.
• It offers limited liability to members.
• It must be registered at Companies House.
• Annual accounts must be prepared and filed. There are other filing requirements, similar to those for the limited company which have time limits for compliance.
• The partnership agreement is confidential to members.
• Withdrawals may be clawed back, if the partnership is declared insolvent within the next two years.
• If you are a member of a trade association, check to see whether it has any conditions which may apply to your registration as an LLP.
• Being a member of an LLP can minimise NI contributions.