Partnership or company. which should you choose?
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This article gives a comparison between a company and a partnership as a business structure. We provide other articles on partnership, limited liability partnership, and limited partnership as well as on limited companies and changing your business structure. These might be useful to read once you have read the information on this page.
Should you form a partnership or incorporate as a company?
Whether you choose a company or a partnership structure depends on the balance you are willing to strike between cost of administration, tax costs, start up costs, privacy, control and liability. For most business people, the decision relates tothe differences in tax paid and limitation ofpersonal liability (risk).So we'll start with these.
Rates of tax and transactions taxed change every year. Allowances for different situations (personal or business) can change the amount of tax paid quite dramatically between businesses that appear to be very similar. Different sources of income are taxed differently. We advise that you visit a tax adviser and seek professional advice on how much tax your business will pay based on your cash flow projections. The following is general information and should not be taken as tax advice. The information aims to give you an idea of the differences, not be a source of accurate information on exactly what tax you might pay. We haven't given the latest tax rates as rates change so frequently that this article would be out of date quickly.
A company pays corporation tax, which over the last ten years has been around 20% to 25% depending on the size of the taxable profits of the company. More profitable companies pay more. The company profits are then distributed to the owners of the company via dividends. The rate of tax of dividends has been historically much lower than that on other types of income (to encourage investment in companies). However, there are now banded rates of dividend tax to prevent owner-directors from paying themselves in dividends rather than in salary. Under the lowest threshold, the rate of tax on dividends has been around 10%. The owner of a small company who takes all earnings out the company via dividends may expect to pay about 30%.
An alternative way of taking the money out of the business is for a shareholder to become an employee (possibly, but not necessarily a director). Again, salary is taxed in bands, from not being taxed at all below a certain threshold up to being taxed around 40% to 50% on amounts over a top threshold. It is the company's responsibility to deduct the tax from the employee and pay it to HMRC. The company and the employee must also pay National Income, another type of tax, historically that has been around 10% of the salary for the employee and 1% to 2% for the company.
A company can retain earnings to invest again in the future. If it does this (and doesn't distribute them as dividends), then these earnings have only been charged with corporation tax (which is generally lower than income tax).
Partners are classed as self-employed for tax purposes. They pay income tax on their share of the partnership profit. A partner's share can vary depending on the partnership agreement that regulates the business. If the partner is entitled to a share of income that is taxed at the highest rate, being paid as an employee and a shareholder through a company structure may save some tax.
Partners also pay Class 2 National Insurance contributions (flat rate) and Class 4 (around 9% to 11% over a certain threshold).
The word "limited" when referring to a public or private limited company refers to the limited liability of the shareholders for the company's debts. If the company enters into a contract that it cannot complete, then it is the company that is liable for any debt not the shareholders. Creditors have recourse only to the assets of the company and not the assets of the owners. There are circumstances where the directors of the company can be pursued for the debts of the company (and the directors may also be shareholders), usually where they have acted outside their authority as directors.
Every partner is personally liable for the collective debts of the partnership. In legal jargon, partners are jointly and severally liable for partnership debts. It is important to point out that a partner's liability doesn't stop with his 'share'.A creditor may choose which partner or partners to pursue for a debt, irrelevant of whether the partners were the ones who signed up to the contract. It is possible (and many partners have) to lose all personal assets as a result of a foolish action by another partner.Protection for partners can be limited to a degree by the partnership agreement (by limiting who can do what) or by using a Limited Liability Partnership vehicle.
A company is a single legal person (known as a body corporate), able to make contracts through its directors or other staff.Directors run the company on a day to day basis and make many of the operational decisions.Shareholders generally make decisions about how the company is run (e.g. they may appoint the directors to the board). Neither directors nor shareholders are employees by default, by they may be in addition to being a shareholder or a director. Likewise, directors do not have to be shareholders, but many are.
A partnership is made up of individuals, any one of whom may commit the partnership to any agreement. The partners have a collective responsibility for all the tax of the partnership and for all other partnership debts. The partners may make their own arrangements for division of tasks, responsibility and liability. A partner is not an employee. Together, the partners together may employ others.
Sale and transfer
A company can be divided into units (shares) and those shares can be sold. This makes obtaining investment and transferring ownership easy. Companies exist without their founder shareholders. If a shareholder dies, his interest can be transferred to someone else, and the transfer confers the same rights to the new owner.
A partnership share can be sold, but it usually can be restricted or made more difficult by other partners, making a share less valuable than the equivalent in a company. It is also hard to sell part of a share.
A partnership only lasts while there are partners. If all but one partner dies, the partnership ceases to exist.
A company exists and performs entirely within a legal framework defined by a number of Companies Acts (the most important one being the Companies Act 2006). This framework sets out the duties of directors, the company as a corporate body, and the shareholders.There are rules on what information must be recorded and reported, to whom and how often. Companies are strictly regulated and there is much bureaucracy in administering them.
A partnership is barely regulated. The Partnership Act of 1890 applies to partnerships that don't cover certain points in their partnership agreement, but otherwise partners can do whatever they collectively agree. Less regulation gives a partnership scope for a less formal, more flexible and more easily changed structure.However, the PA 1890 does not deal with the many complications of trading a century after it was passed. Resolution of disputes between the partners, and divisions of partnership assets can cause particular anguish if they are not properly covered in the partnership agreement.
Public disclosure and privacy
By law, a company must provide certain information to the Registrar of Companies on an annual basis. This information is open to public inspection, allowing anyone can see the names and private addresses of directors, the names of shareholders, the financial performance of the company and all the other information filed.
A partnership does not have to disclose any information publicly.
This is a matter of practice and choice rather than of law.
Job descriptions of employees and the management structure of the organisation can be ascertained easily. It should be clear who is responsible for making which decisions. Likewise, directors and shareholders should be easy to identify.
Although there is no difficulty in principle in setting out a precise set of duties, obligations, and rights for each partner, in practice partners tend to think of themselves as equal. Who makes the important decisions and how can be difficult to ascertain and manage. The roles, limits or authority and responsibilities of partners need to be set out very clearly. Whether a partner is just an owner (like a shareholder) or whether he or she can act (like a director in a company) depends on what has been agreed in the partnership agreement, if any exists.
The cost of starting either a partnership or a company is relatively low. Companies can be bought off the shelf for £50 or less, and using services such as Net Lawman, a partnership agreement can be bought for slightly less.
The real cost is the on-going cost. A company requires statutory filings, which are time consuming to carry out and which can require payment of fees.
So should you choose a company or a partnership?
The answer to this question will depend on your circumstances. Both structures have advantages. Once you have made a decision, you are not unable to change later on. Most businesses start as sole traders and move to partnerships before becoming incorporated. The disadvantages of both structures can be overcome to some degree using either a good shareholders agreement, or a comprehensive partnership agreement.
We also have the following articles on business structure that may be of interest:
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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