Organisational structures and registering with HMRC

One of the first things you must do as a new business in London is to decide on an organisational structure and register with HM Revenue & Customs (HMRC).

There are a number of different types of organisational structure, each with different requirements and suitable for different types of businesses. This guide explains the main legal structures available to your business.

The main structures for commercial organisations – in other words, profit-driven businesses – are:

• Sole trader.

• Ordinary partnership.

• Private limited company.

• Limited liability partnership (LLP).

• Community interest company (CIC).

If you're a charitable organisation, you'll need to register as a charity or a charitable incorporated organisation (CIO).

Sole trader

For tax purposes, HMRC treats sole traders as self-employed. Sole traders account for the vast majority of small organisations run by one or two people.

If you're a sole trader, you keep all your business profits after tax, but you're also personally liable for your business' debts. This means that your home and other personal assets may be at risk if you can't pay those debts.

As a sole trader, you must register with HMRC for tax self-assessment as a self-employed person. You must also complete a yearly self-assessment return, and pay income tax and National Insurance contributions.

Pros and cons of being a sole trader

Pros

• Low cost.

• Easy to set up.

• You retain full control of the business.

Cons

• Full liability for debt.

• No separate legal entity – it is you who is sued and responsible for debt.

Partnership

An ordinary partnership, or simply a "partnership", involves two or more people conducting business activities in order to make profit.

If your business is owned by two or more sole traders, this could be the perfect organisational structure. You don't need to register an ordinary partnership with Companies House.

You and your partners have unlimited liability for the debts of your business. This means you can each be held responsible for transactions or contracts that any of your other partners enter into.

HMRC treats partners as self-employed in the same way as sole traders, and partners keep and share all their profits after tax. As they are treated in law as a legal person, private limited companies can also enter into partnerships as a partner.

If you decide to go into a partnership, it's a good idea to ask a solicitor to draw up a partnership agreement before starting to trade. The partnership agreement clarifies each partner's legal position and provides a framework for dealing with any problems that could arise.

Pros and cons of a partnership

Pros

• A partnership is generally easier to form, manage and run.

• More potential to raise finance.

Cons

• Full liability, affecting all partners.

• Partners can disagree on business matters.

• No separate legal entity – partners are jointly and severally liable.

Private limited company

A private limited company is a separate legal entity to its owners. This means that you and the other owners of the company, or members, benefit from "limited liability".

In other words, if something goes wrong and the company needs to pay debts, your personal stake in what needs to be paid back is limited to the amount of money you put in originally (normally a very small amount). Your private limited company can own property and other assets.

A private limited company must be set up through Companies House and registered with HMRC. It can be "limited by shares", which means that your and other members' liability is limited to the money you've each invested buying shares in the company.

It can also be "limited by guarantee". This means that your liability is limited to the amount you've agreed to contribute to your company's assets if you wind up your company.

Pros and cons of a private limited company

Pros

• Less personal financial exposure.

• Limited liability protection.

• The company is a person in the eyes of the law, so it's the company that enters into contracts, and it will usually be the company that is taken to court.

  Of course, the directors are responsible for managing the company – and there are instances where personal liability arises – but provided those running the company have taken the time to understand what their responsibilities are, and carried those responsibilities out, they won't be held liable if things go wrong.

Cons

• Involves set-up costs.

• Annual accounts and financial reports must be placed in the public domain.

Limited liability partnership

A limited liability partnership (LLP) is a legal structure that lets you set up a business with one or more partners while limiting your personal liability (as with a limited liability company). An LLP is also similar to a private limited company in that it has a separate legal identity to that of the partners, or members.

In many ways, LLPs operate in exactly the same way as ordinary partnerships. However, you must register LLPs with Companies House.

Members of an LLP can be either individuals or limited companies (known as "corporate members"). Individual members will usually be treated as being self-employed for tax purposes, and must be registered for self-assessment with HMRC. You and other members act as agents for the LLP and can form binding contracts on its behalf.

Each LLP must have at least two "designated members" who are responsible for various administrative duties, such as dealing with accounts and tax matters on behalf of the partnership.

Since the LLP has a separate legal identity to its members, legal claims against your business can only be made against the LLP itself and not you as a member. Your personal assets also can't be seized to settle the partnership's debts.

Management of the partnership is usually shared among the members, as specified by an LLP agreement. This is a contract between the members of the LLP, which sets out members' rights and obligations.

It also provides a plan for how you'll run the partnership. It's best practice to ask a solicitor to draw an LLP agreement before starting to trade.

Pros and cons of an LLP

Pros

• Flexibility: can be incorporated in a members' agreement.

• Has the benefits of a limited company and a partnership combined.

Cons

• Partners must disclose their income.

• LLP must start to trade within a year of registration.

Community interest company

A community interest company (CIC) is a specific type of limited company that runs commercially as a social enterprise and has clear social objectives, such as providing employment opportunities for people with disabilities.

CICs must be registered with the Office of the Regulator of Community Interest Companies and pass a "community interest test" before being approved. This test makes sure that a CIC's activities benefit the community.

You can set up new CICs as private companies limited by shares, or as private companies limited by guarantee. CICs that are limited by shares and that make a profit can distribute some of their profits to shareholders, subject to certain conditions.

There are restrictions on the distribution of profits to shareholders to ensure that CICs use their assets and profits for the benefit of the communities they serve.

Pros and cons of a CIC

Pros

• A clear commitment to social goals.

• Access to certain forms of finance.

• Limited liability and protection.

Cons

• Ongoing administrative burden.

• Not all charitable funding is available.

• Difficult to change from a CIC to another structure.

Charity

A charity is an organisation set up to provide a specific community benefit. To qualify, it must have "charitable purposes" and be run by a board of "trustees".

Charities can be unincorporated or incorporated. An unincorporated charity is a simple way for a group of volunteers to join together for a community purpose. However, an unincorporated charity can't enter into contracts and the trustees are personally liable for losses (similar to a sole trader).

An incorporated charity can either be a charitable company or a charitable incorporated organisations (CIO). They are registered with the Charities Commission and have similar obligations to a private company.

"Hybrid" model

It's increasingly common for organisations with charitable aims to set up as a charity and then to realise that they have a product or service they can sell in order to generate money for the charity.

As a charity, you can't just go out and make profit – you need to set up what's often called a "trading arm". This is where the charity sets up a separate company (using one of the structures above) and any trading they do to generate money is conducted by that company.

A great example of a trading arm is a charity shop. These are operated as commercial operations, but the profit they generate is gifted to the charity. To the public, they are one and the same, and they know that any money they spend in, for example, the Oxfam shop goes to the Oxfam charity.

If you like the values and benefits of a charity, but you also know you'll need to generate money, a hybrid model could be a good option for you.

Who is in charge?

When you set up a new business, depending on the structure, you may be able to run the organisation yourself, or you may need to bring in directors, members, trustees etc. to assist. In some organisations, there is a set number required. In others, such as a sole trader, you just need yourself.

When deciding on your structure, think about whether you want to have more people involved. Bringing in leadership talent can be a good way to involve experts.

A charity can be a useful structure if you want to apply for certain funding, and you have a real desire to use your organisation to benefit your community. There are different pressures when running a charity though (mainly making sure you can stick to your core aims), so it isn't a structure to choose lightly.

Hints and tips

• Solicitors and accountants can help you make decisions about legal structure, as well as helping with the practical procedures involved in setting up more complex structures, such as LLPs and private limited companies.

• As your business grows, you might need to review your structure to meet changing business needs.

• It is possible to change your legal structure, but this may cause problems by disrupting business activities, and it can be costly and time-consuming.

Your cultural and community space toolkit

If you're reading this guide as part of the toolkit for opening, running and growing a cultural or community space, next look at step 3: key contacts and organisations for start-ups.

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