All businesses are required to report their annual accounts to the government for tax purposes at the end of the financial year. The annual accounting statements are also used by enterprise owners to evaluate the success of their business operations. Moreover, the Her Majesty Revenue and Customs (HMRC) regularly checks the company accounts to assess if all taxes have been paid regularly and if regulations have been followed. Along with being accurate and fair, company accounts also have to be compliant with the industry accounting standards and tax legislations.
Company accounts are usually categorised as:
- Sole trading accounts
- Partnership accounts
- Limited company accounts
All three types of company accounts have to be managed in different ways. Here are the basic difference between these accounts.
||Sole Trader / Partnership
||As the company is solely-owned or by the partners, anything that goes wrong legally or financially, the brunt has to be bored by the owners/partners.
||For a limited company any issue is dealt at the company level and the Director doesn’t get affected – financially or legally if the statutory compliances have been adhered to.
||To start the business the formalities and registrations are nominal. You only need to ensure that you register yourself with the HMRC within 3 months.
||A lot of setup cost as the number of registrations and statutory compliance is very high.
||For both sole and partnership accounts, the statutory compliances to meet are very less.
||In a Limited company these are many that need adherence and have frequent audits.
||Mostly all information is confidential and is with the owner / not shared publicly.
||All information like company financial data, Director’s salary, sales and related is available publicly.
Understanding Sole Traders, Partnership and Limited Companies in Detail:
When an individual decides to start a business and begins chasing leads and generating sales from customers, he/she starts functioning, by default, as a sole trader. The first thing that a sole trader should do is to get registered with the HMRC. The registration can be done online on the HMRC website or by filling the CWF1 form within three months of starting the business.
Income Tax and Class 4 Insurance
All sole trading accounts are liable to income tax and the Class 4 National Insurance on the profits made. For starters, sole traders have to maintain records worth six years of client invoices and business expenses. They have to keep track of the money earned throughout the financial year, along with expenses and have to file their personal tax declaration to declare business profits for the accounting year. They are also required to pay the self-assessment tax.
It is not mandatory for sole traders to register their company name or set up a business bank account, but many sole trading companies do them anyway to prepare for the future. Having a registered company name helps build customer trust via credibility, and on the other hand, it is always a good idea to keep the business and personal bank accounts separate. However, it is mandatory for sole trading companies to register for National Insurance. Once registered with HMRC, sole trading companies start receiving bills for quarterly National Insurance Class 2 contributions and annual Class 4 contributions. Moreover, sole trading companies don’t need to register for VAT as long as they are below the £85,000 threshold. For tax payments, sole traders have the flexibility of paying twice a year: first on the 31st of January and the second on the 31st of July via the ‘payments on account’.
When two or more people get together to start a business that is not a limited company, they usually form a partnership which work very similarly to sole trading companies, and the business partners are all self-employed individuals. To register a partnership business with the HMRC, one of the partners must be designated the ‘nominated partner’, who will be responsible for registering the company and sending the partnership tax returns to the HMRC, whereas the rest of the partners should register separately and inform the HMRC that they are now self-employed. Moreover, all partners have to separately file their individual tax returns.
Partnership accounts can be registered online or by filling the SA400 form. When a partnership is registered, the nominated partner automatically gets registered for self-assessment. All individual partners are personally responsible for any loss or debt incurred in the partnership business.
Taxation and National Insurance
For tax purposes, partnership accounts are supposed to submit annual self-assessment forms to the HMRC, one on behalf of the partnership along with separate forms for each partner. It is also crucial to maintain up-to-date records of all business profits, losses, transactions, receipts, invoices, etc. Income tax and National Insurance contributions are to be paid on the overall profits made by the partnership.
Legalising the Partnership
Since partnerships are not assigned any legal status, even if one of the partners backs out, the entire partnership has to be dissolved. It is, therefore, advised that the partnering individuals sign a partnership agreement wherein all aspects of the business are addressed, including how to manage future hiccups. All profits from the partnership are equally shared among the partners, and each partner is deemed to pay taxes on his/her individual share. Partnership businesses can be traded under the actual names of the partners or a single name can be chosen for the entire business. Just like sole traders, it is not mandatory for partnership companies to register their business name.
Limited companies operate as separate business entities in which the company owners/directors are legally responsible for paying the company’s debts, but only to the extent of their investments in the company. The first task is to register the company with Companies House. This process is known as incorporating the company, and it will require the following details:
- A company name that is not similar to any other limited company; Companies House doesn’t permit offensive names or the use of certain sensitive words or phrases
- A suitable company address
- At least one decided company director
- Details of company’s shares, with at least one shareholder (who may also be the director)
- Company’s nature of business and SIC Code
A limited company can be registered online, via the post or with the help of agents and third-party software. The government’s online services can be used to register the limited company for corporation tax and PAYE (informing HMRC that employees will be hired, including the company directors).
Taxation and National Insurance
If employees and directors are receiving salary, then the income tax and the National Insurance Contributions (NIC) are deducted at the source. Moreover, the corporation tax registration has to be done within three months of starting the limited company, post which the HMRC notifies the deadline for paying the corporation tax. Thereafter, the company tax return has to filed, even if the business is in loss or has no corporation tax to pay. Limited companies are also required to register for VAT, which can be done online on the HMRC website. Limited companies may also encounter additional taxes such as the income received personally by the owners, especially in the form of salary or dividends drawn.
A quick note on pros and cons of sole trading, partnership and a limited company.
|Sole Trader / Partnership
|In case of debts a sole trader or partners are liable to pay
||In a limited company, a director is liable to pay to the extent of unpaid amount on shares.
|In a legal dispute, the owner is sued.
||In case of a limited company, the company is sued and it is very rare that the director is.
|Owns the business and is self-employed.
||Director is treated as an employee.
|Pays class 2 & 4 of the NI (National Insurance)
||The company pays corporation tax on the profits.
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