One of the many aspects a business owner needs to consider is how to legally structure the operation. For the small business the choice is usually between being a sole trader and operating through a limited Company. Broadly speaking three aspects should be considered – Legal, Accounting and Taxation.
From a lawyer’s perspective the most attractive element of the corporate structure is limited liability. The Company is a separate legal entity from its owners. The company has its own debts. The owners (shareholders) are not responsible for these debts. The business owner can therefore choose how much money to commit to the business. He will not be responsible for trading losses or amounts due to creditors if the business fails.
Care needs to be taken in the small business in that shareholders will usually also be directors. Directors need to make sure that the company does not trade while insolvent as otherwise they can become personally responsible for debts that should properly be those of the company. Insolvent means that the Company can not pay its bills as they become due.
Shareholders have no liability for damages arising from litigation against the Company. This is an important consideration. It is prudent to insure against risks in so far as possible regardless of the business structure employed.
Unfortunately when Banks lend to a Company the Bank will probably insist on getting a personal guarantee from the directors. In many cases therefore, while Bank debts may be due by a company, the directors will also have a personal responsibility to pay them.
Accountancy advice should always be sought when incorporating. There are additional obligations in relation to filing accounts and possibly preparing audited accounts which do not arise in relation to the sole trader but will be an aspect of running a business through a limited company. Also proper books of account have to be maintained as a matter of law.
Expert taxation expert advice should be sought for each particular case. However, the current corporation tax rate is lower than personal income tax rate. It is important to bear in mind however that this applies to money earned by the company and retained by the company. If the shareholders pay themselves fees salaries or dividends, then these are subject to full income tax. The corporate structure can be very advantageous in a situation where a company is making more profit than the owners need. Surplus profits can be accumulated in the Company at far lower tax rates than is the case for the sole trader. This money is then available for further investment by the Company in the business.