This article is for educational purposes and does not constitute legal, financial, or tax advice. For specific advice applicable to your business, please contact a professional.

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Your business entity is the legal structure of your business. It determines what laws apply to your business. In particular, it determines what taxes you pay. Here is a quick guide to choosing the right business entity for you.

What is a business entity?

The UK has three main types of business entities. These are:

1. Sole trader (also known as a sole proprietorship)
2. Partnership
3. Limited liability company.

Partnerships can be further divided into general partnerships and limited partnerships (or limited liability partnerships). Limited liability companies can be further divided into standard limited liability companies (Ltds) and public limited liability companies (PLCs).

Technically, standard limited liability companies can be further divided into two types: companies limited by shares and a companies limited by guarantee. The limited-by-guarantee business structure is typically used for non-profit-making organisations. Profit-making businesses typically use the limited-by-shares business structure.

You have to choose a business entity when you start a business. This is so that HMRC can assess your taxes correctly. It is possible to change from one type of business entity to another. However, it’s best to minimise the number of these changes, since they entail some administration and hence usually extra costs. Changes to your business structure may also cause confusion.

How to choose a business entity

Your choice of business entity depends on your goals for your business. Here is a quick guide to what your choice of business entity can mean for your business.

Ease of set-up

Setting up as sole trader simply requires you to register as self-employed with HMRC. Forming a partnership or a limited liability company requires more administration and cost.

There is plenty of help available for this. If you have an accountant, they may be able to take care of this for you. If you don’t, hire a company that specialises in guiding people through registering partnerships or standard limited liability companies.

If you want to set up a public limited liability company, there is a significant amount of administration. It would be highly advisable to get professional help with this.

Ownership structure and succession rules

A sole trader is an individual. The individual is their business and vice versa. Technically, a sole proprietorship cannot be sold. In reality, a sole trader can sell or licence assets relating to their business.

A partnership is owned by its members. It is operated under a partnership agreement. This partnership agreement should lay out the procedure for one or more members wishing to leave the partnership.

A company limited by shares is owned by shareholders and managed by directors. Shareholders may or may not be directors, and vice versa. When a limited liability company is registered, there must be at least one shareholder named. If more than one shareholder is named, the percentage of each holding must be set out. At least one director must also be named.

The company shares are assets. They can therefore be treated in much the same way as any other asset. For example, they can be sold or passed on as a part of a person’s estate. If the ownership of shares is transferred, the transfer is assessed for tax per the standard rules for that type of transfer.

Directors have a contract with the company. This may be a service contract or an employment contract. Either way, the rules for their succession should be set out in that contract.

Tax assessment

A sole trader pays Income Tax and National Insurance. This is declared through a self-assessment form.

A limited company pays Corporation Tax. This is also declared through a self-assessment form. If money is withdrawn from a limited company, it is assessed for tax according to the category of withdrawal. For example, salaried/waged employees pay Income Tax and National Insurance. An owner taking dividends pays Dividend Tax.

A partnership does not pay tax at all. All profit is passed straight through to the individual members of the partnership. This means that all members have to be separately registered with HMRC. They can choose to be either sole traders or limited companies. Their tax is calculated according to the entity they choose.

For completeness, liability for VAT depends on your turnover rather than your business structure. This means that a sole trader could be required to register for VAT.

Financial records

All businesses are required to keep full and accurate tax records. A sole trader can keep all their financial records entirely private if they wish. A standard limited company must put some financial information into the public domain. A public limited company has to publish extensive financial records.

Personal liability

A sole trader has full, personal responsibility for their business’s liabilities. This risk can be mitigated with insurance.

Limited companies are considered ‘legal people’. This means that their liabilities cannot usually be transferred to directors or shareholders. Shareholders can generally only lose the money they put into the company. This is because it ceased to be their money when they swapped it for shares.

With a general partnership, the members are personally liable for the partnership’s obligations. If the members are limited companies, then the liability usually rests with the limited company, not its shareholders.

With a limited partnership, each member’s liability is restricted to what they put into the business plus any personal guarantees.

Limited liability protection is not absolute

There are some instances where a company director and members of an LLP can be held personally liable for their business’s liabilities. This is typically if they are held not to have acted in good faith.

It’s therefore advisable for company directors to ensure that they always record the reasoning behind any important decisions they take. It’s also advisable to get professional advice quickly if a company is in financial difficulties. This may help to protect directors or members from allegations that they knowingly traded while insolvent.

Note that a new limited company will not have a credit history. It may therefore struggle to access loans in its own right. If directors or shareholders give personal guarantees for company loans, then they are personally liable for them.

Useful resources for choosing a business entity

• Regardless of your business type, you’ll need to know about your responsibilities as an employer, including auto-enrolment. Learn more here.

• Find out more about different business structures here.

• Educate yourself on business taxes here.