The Language of Small Business Texts and Vocabulary Training (for students of Economics) Part 2. Учебное пособие

Международный консорциум «Электронный университет»

Московский государственный университет экономики, статистики и информатики

Евразийский открытый институт

И.Н. Достoвалова

The Language

of Small Business

Texts and Vocabulary Training

(for students of Economics)

Part II

Москва 2008

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The Language of Small Business

UNIT 1.

Your Business Identity

An important decision to make early on is to decide what legal form your business will take. Whatever you decide is not irrevocable, but it will take time and money to undo mistakes.

You can choose between:

−sole trader;

−partnership;

−limited company;

−cooperative.

If you want to work on your own, your choice is either sole

trader or limited company. If you want to work with others, your choice is between partnership, limited company or cooperative (or you could be a sole trader if you intend to employ others, rather than work with them).

The form you choose can hinge on emotional factors, as well as objective ones. If you choose a cooperative as your form, this may be because of political, social or ethical reasons. If you choose a partnership, this may be because you have a close colleague with whom you work well. However, the choice between a sole trader or limited company will probably be made because of monetary reasons, such as which is best from the tax point of view.

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Your Business Identity

SOLE TRADER v. PARTNERSHIP v. LIMITED COMPANY

There are several elements you have to look at so that you can weigh up the pros and cons of each legal form.

1. THE CREDIBILITY OF THE BUSINESS

There is probably very little to choose between a sole trader and a partnership when it comes to credibility. On the whole, it is thought that a limited company may give your business more credibility; but this may not work if a customer researches your company and finds, for example, that it has a paid-up capital of £100, which is the typical situation of a very small business.

2. WHAT HAPPENS WITH MONEY YOU OWE

If you are a sole trader, you are liable for all the money your business owes (your liability is unlimited). Your own personal assets, such as your house, furniture and car, can be seized to pay your business debts; in the final breakdown, you can be made bankrupt.

This unlimited liability also applies to a partnership, with a further drawback: you are liable for your partner’s share of the debts, and this may include an unpaid tax bill on partnership income.

By contrast, the concept of limited liability appears very attractive. Shareholders’ liability for debt is, in most cases, limited to the amount they paid for their shares in the first place. The personal assets of directors can only be touched if that company has been trading fraudulently. But this protection for your personal assets may be illusory. When you are starting in business and still operating on a fairly small scale, it is common for you as a director to be asked for personal guarantees, against the business debts. This includes bank overdraft, leasing agreements for cars and

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The Language of Small Business

equipment, rent for premises and could include money you owe suppliers. However, once you have become established and successful you may be able to shed your personal guarantees, whereas a sole trader or partner cannot shed unlimited liability.

Summary

If yours is the sort of business which buys materials or services from other business, needs a small overdraft or has to operate from rented premises, forming yourself as a limited company has the edge. You may be able to get away without guaranteeing all of these debts; it is certainly worth negotiating to avoid doing so.

3. WHAT YOU DO TO START UP

It is very easy to start up as a sole trader.

In theory, it is equally simple to start a partnership, as you do not have to get a written partnership agreement. But, this would not be a sensible or businesslike approach. Partners argue, including members of the same family; you should accept that this may be so, no matter how unlikely it appears when you start your business. You must get a solicitor to draw up a written agreement which covers things like profits split, work split, tax split and partner changes.

You can start a limited company from scratch. Alternatively you can buy one «off-the-peg», which costs between £100 and £140, and for a further £40, you can change its name. In either case, you need two people as shareholders: one to be a director and the other to be the company secretary.

Summary

Setting up as a sole trader involves the least work and fewest formalities.

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Your Business Identity

4. YOUR ACCOUNTS

As a sole trader and a partner, your accounts need to show a true and fair picture. But the exact form of the accounts is not laid down by law. In practice, this means you do not have to produce a balance sheet. It would, however, be advisable to do so to impress your tax inspector.

In contrast, the form of accounts for a limited company is laid down by law.

Summary

The rules about your accounts are more onerous if you set up as a limited company.

5. GETTING YOUR ACCOUNTS AUDITED

As a sole trader or partnership, you do not have to get your accounts audited, if you do not want to. You may want to consider doing so, if the cost would not be too exorbitant, as it can help in dealings with your tax inspector. It may also help you if you need confirmation of income from your business – for example, to get a mortgage to buy a house.

If your business form is a limited company, you have to get your accounts audited by an accountant.

Summary

The rules about auditing of accounts only apply to a limited company.

6. THE RATES OF TAX ON YOUR PROFITS

If you operate as a sole trader, you will pay normal rates of income tax on your profits (including any salary you pay yourself) – either at the basic rate (25 per cent) or the basic and higher rate (40 per cent).

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The Language of Small Business

The amount of tax charged on profits from a partnership depends on the income tax rates paid by individual partners on their income. But the tax which each of you pays will depend on what you put in your partnership agreement.

As a director of a limited company, you will pay tax on your salary at the normal rates of income tax – up to 40 per cent. You pay corporation tax on the profits which you leave in the business.

Summary

If you are paying the higher rate of tax on the profits from your business as a sole trader or partner, you could pay less tax if you form a limited company.

7. WHEN YOU PAY TAX

Once you have been going two or three years as a sole trader or partnership, you will normally pay tax on what’s known as a preceding year basis. The effect of this is that you could pay tax up to twenty months after you earned the profits. This is an advantage and helps your cash flow if your profits are rising each year.

The rules are stricter if you run a limited company. On your salary, you pay tax each month under the PAYE system. On the profits of the company, you pay tax nine months after the end of the accounting year.

Summary

There may be cash flow advantages if you pay tax as a sole trader or partnership, rather than as a limited company.

8. WHAT YOU CAN DO WITH LOSSES

If you are a sole trader or in a partnership, you can set off losses:

− against future profits of the same trade

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Your Business Identity

− against other income in the year of the loss or the year after. This includes any personal income you may have.

If you form a limited company, the relief is not so generous. You can set off losses:

−in one period against company profits of the previous period of the same length;

−against future profits of the company;

−against any capitals gains the company makes.

Summary

If you are likely to make losses in the first year or so, you would be better organizing your business as a sole trader or partnership, if you have another source of income.

9. PROVIDING YOURSELF WITH A PENSION

The amount of contributions a company can make to a pension scheme free of tax is limitless. As well as the contributions your company can make on your behalf, you can also invest up to 15 per cent of your salary as a director and employee, and get tax relief on the full amount at your highest rate of tax.

In contrast, if you are a sole trader or in a partnership, the maximum relief is between 171/2 and 40 per cent of your taxable profits (strictly, net relevant earnings).

Summary

The advantages are weighted towards a limited company.

10. CAPITAL GAINS IN THE BUSINESS

As an individual, if you sell something and receive more for it than you paid, you have made a capital gain. You may also make a capital gain if you give away an asset or dispose of it, and

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The Language of Small Business

its value at the time is higher than the original cost. A certain amount of net capital gains are free of tax each year.

But if you form a limited company, you face a double tax if you make a capital gain when you sell one of the assets of your business. There is no tax-free limit, so corporation tax is due on all gains, although it could be at a lower rate than for an individual, 25 or 35 per cent. If you want to get your hands on the proceeds, you can only do so in the form of salary or dividends; and this means income tax to be paid on top of tax already paid.

Summary

If you want to sell an asset of your business, it depends on the level of your profits as to whether your business would be better as a sole trader or partnership, rather than a limited company.

11. RAISING MONEY

If you need money for your business, the form of your business can dictate your choice.

As a sole trader, your options are fairly limited and basically depend upon your bank manager and getting an overdraft. As an outside possibility, you may find an individual who could lend you the money.

In a partnership, you may be able to find a new partner to bring in some extra capital.

But, if you form a limited company, the choice is wider. You may be able to raise venture capital from a fund; and you can only raise money under the Business Expansion scheme if you are a limited company. You may also be able to raise money from your bank secured with what is known as a floating charge on your assets.

Summary

Your choices for raising money are wider if you form a limited company.

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