Which business structure is the most tax-efficient?

Tax represents one of any company’s most significant expenses.

Depending on the business structure, profits or income minus expenses may be subject to Income Tax, National Insurance, Corporate Tax and VAT.

Choosing the right business structure can substantially reduce your tax bill and provide much-needed funds for reinvestment in your operations.

How is my business structured?

You have a range of options in terms of your business structure, each offering its own benefits and drawbacks, including acting as a:

·        Sole trader – A business owner trading alone and controlling 100 per cent of the business.

·        Partnership – Two or more business owners share personal responsibility for the business and share its losses, profits and expenses.

·        Limited liability partnership – Similar to a partnership, except partners create an entity separate from themselves to limit financial risk.

·        Limited company – A more complex structure which protects individuals from risk and allows owners to sell shares and have shareholders.

Generally, limited companies offer the most tax-efficient business structure.

This is because they have different tax arrangements to other types of businesses, which open the door to additional reliefs and a lower overall rate of tax.

Rates of payment

One of the major differences between limited companies and other business structures is how its owners pay tax.

Sole traders and partners within a partnership must pay their own tax through Self-Assessment, subject to National Insurance and Income Tax payments.

If you’re currently using one of these structures, you know that this can create a significant tax liability. Earnings above £12,570 are taxed at 20 per cent, rising to 40 per cent on earnings over £50,270.

In contrast, a limited company pays Corporation Tax on its profits, which is currently 19 per cent for small businesses and 25 per cent for ‘main rate’ companies with profits over £250,000.

This is typically less than tax paid as Income Tax, depending on the level of earnings.

Allowances

Limited companies also have a range of capital allowances available to them, which can make investing in new equipment much more cost-effective.

For example, companies which invest in machinery may be able to make use of the annual investment allowance (AIA).

This allows businesses to deduct the full value of a qualifying item from profits before calculating Corporation Tax – lowering their bill and facilitating investment.

Shouldering the risk

Related to the amount of tax you pay, your company structure will also affect who bears the financial risk of your business.

For example, if you receive a large tax bill or fail to meet projected profits, the responsibility lies with the company and will not affect your personal finances or credit.

This can be incredibly useful for business owners looking to grow and take on debt to fund innovations.

Other considerations

Although tax efficiency takes the crown, business owners need to consider a range of factors when selecting the right business structure.

For example, while sole traders may need to pay a higher rate of tax than limited companies and their directors, they also benefit from simplicity and ease of scaling up.

As a sole trader, you can:

·        Easily register with HMRC online and file through Self-Assessment to pay your taxes

·        Scale the business up or down without needing to dissolve or re-register the company at a later date

·        Avoid incorporation fees and the complexity of filing through Companies House

·        Keep full control over your business and profits

The reality is that a limited company will not be the right choice for every business owner.

Without the time, legal expertise and financial know-how to properly manage a separate entity, sole traders or small entities such as partnerships may struggle to operate an LLC.

For smaller businesses however, which are still able to manage the administrative requirements of being a limited company, doing so may be the ideal way to bring tax efficiency to the forefront.

For advice on business restructuring, please get in touch with the Iceberg Accounting team to speak to one of our experts.