Setting up a business is an exciting time, especially during the preparation stage. Deciding the business name, branding and the business offering are typically top of an entrepreneur’s priority list but one item on the business agenda that is frequently forgotten is tax.
In the first instalment of our ‘Lifecycle of a business’ series, our corporate tax team consider some of the initial decisions you need to make prior to setting up your business and the varying tax implications.
Producing a business plan
After conducting thorough market research, creating a detailed business plan is the first step when preparing to set up your business.
Some key considerations that will inform the content of the business plan include:
- Defining the target market
- The products/services the business will provide
- How the business will be financed – will you need to borrow money?
- Looking at how long it will be before the business is able to turn a cash surplus
- What management and organisation structure will be most suitable for those involved
Consider what type of business you wish to set up
When setting up a business, there are different structures to consider. These include:
- Sole trade
- Partnership
- Limited company
- Limited Liability Partnership
- Franchising options
You will need to decide on a structure that best suits your business model, as well as taking into consideration a variety of legal, commercial and administrative factors.
From a tax perspective, whilst all business structures can benefit from enhanced tax reliefs such as Business Asset Disposal Relief and/or Business Property Relief, subject to certain conditions being met, there are other tax benefits and disadvantages specific to each type of structure that should be carefully thought through. The advantages and disadvantages of the different business structures have been considered below:
| Sole Traders and Partnerships | |
| Advantages | Disadvantages |
| Sole traders and partnerships are relatively easy to set up, with low administration burdens. | Business and personal financial affairs are not legally separate if you are a sole trader or a partner in a partnership. |
| The National Insurance Contributions (NICs) due on profits are also at more favourable rates. Rates for the 2024/25 tax year are:
•Class 2 (profits of £6,725 or more a year): £3.45 a week •Class 4 (profits of £12,570 or more a year): 6% on profits between £12,570 and £50,270, 2% on profits over £50,270 |
Profits are taxed regardless of whether they are drawn or remain in the business – this can make a big difference depending on business size and profitability. |
| If you are self-employed and not paying NICs, you may be eligible to pay voluntary National Insurance Contributions. These contributions help to fill gaps in your NI record ensuring you still qualify for certain benefits, including State Pension. | Businesses with a sizeable income will be taxed at higher rates. These will benefit from leaving their profits in a corporate vehicle if they do not need to be drawn on. |
| Companies | |
| Advantages | Disadvantages |
| Limitation of liability clauses for companies mean that once a company is incorporated, it is a separate legal entity to the directors. This means that the legal and financial responsibility for all debt and liabilities accrued by the business is separate to the Directors’ personal affairs. | As opposed to individual traders, the administration of a company can be complex. Directors also need to be aware of their legal duties to ensure they are not at risk of any financial penalties or personal liability. |
| Retained profits are subject to lower tax rates than unincorporated businesses. | Individuals who sell their services through Personal Service Companies (PSC) may be affected by the implications of IR35. The rules mean that payments made to PSCs are subject to personal tax rates, including PAYE and NICs, rather than corporate tax rates. |
| Most directors of limited companies pay themselves in some combination of salary and dividends to extract profits in the most tax efficient way. Dividends do not attract NICs, are taxed at a lower rate than salary payments depending on the individual’s marginal rate of income, and benefit from a tax-free dividend allowance. | If the business owners need to extract all the profits from a company for personal income, then the overall costs including tax of the business can be higher than a non-corporate structure. Directors should also consider the overall cost to the company of different remuneration options. |
| Company share structures can be set up in a variety of ways and this can be useful in the shorter term for remuneration planning and in the long term in passing on the business to the next generation in a fair and tax efficient way. | There is less flexibility for owners who want to be able to separate capital between individual owners. There could also be more complexity, and potential tax implications,, when considering moving property into and out of the company. |
Limited Liability Partnerships and franchising options
In specific circumstances, a Limited Liability Partnership may be suitable, such as when multiple partners are involved in the business, or the risks taken in the business need the protection of limited liability. A franchising option would only be applicable for specific businesses wishing to start their own company and trade under an established brand.
Before setting up a business, there are numerous difficult decisions to make. When it comes to complicated tax considerations, our corporate tax experts can help. Contact a member of our tax team today for specialist advice on business plans and tax related matters.
