45 MINS CPD COURSE BUSINESS PROTECTION UNDERSTANDING BUSINESS STRUCTURES

Transcription

1 45 MINS CPD COURSE BUSINESS PROTECTION UNDERSTANDING BUSINESS STRUCTURES

2 INTRODUCTION THIS COURSE IS PRIMARILY AIMED AT ADVISERS ARRANGING LIFE AND CRITICAL ILLNESS COVER LINKED TO MEETING BUSINESS PROTECTION NEEDS. IT OUTLINES THE MAIN WAYS TRADING BUSINESSES CAN BE ESTABLISHED ALONG WITH THEIR TAX TREATMENT. IT ALSO SUMMARISES THE MAIN FINANCIAL PLANNING CONSIDERATIONS FOR EACH TYPE OF BUSINESS. LEARNING OBJECTIVES To understand the key characteristics of: Sole traders, their tax treatment and financial planning needs. Partnerships and limited liability partnerships, their tax treatment and financial planning needs. Private and public limited companies, their tax treatment and financial planning needs. 1

3 PAGE 3 1. SOLE TRADERS PAGE 4 SOLE TRADERS SOLE TRADER TAXATION FINANCIAL PLANNING CONSIDERATIONS PAGE 6 2. PARTNERSHIPS PAGE 7 PARTNERSHIPS SCOTTISH PARTNERSHIPS LIMITED LIABILITY PARTNERSHIPS PARTNERSHIP TAXATION PAGE 8 FINANCIAL PLANNING CONSIDERATIONS PAGE COMPANIES PAGE 11 PRIVATE LIMITED COMPANIES PUBLIC LIMITED COMPANIES PAGE 12 COMPANY TAXATION PAGE 13 SHAREHOLDER TAXATION FINANCIAL PLANNING CONSIDERATIONS PAGE APPENDIX LOAN PROTECTION EXAMPLES PAGE 16 ANSWERS TO SECTION QUESTIONS 2

4 1. SOLE TRADERS THIS SECTION COVERS SOMEONE WHO S OPERATING A TRADING BUSINESS ON THEIR OWN BEHALF. 3

5 SOLE TRADERS A sole trader uses the simplest form of business structure. They own and control their business, operating on a self-employed basis. The business has no separate legal entity distinguishable From the living individual owning and managing it. This applies even though sole traders often operate using trading names. A sole trader has unlimited personal liability for any debts And obligations they incur in connection with their business. A sole trader often employs other people. SOLE TRADER TAXATION A sole trader is taxed as a self-employed individual. They don t receive salary. Instead, their earnings are their trading profits which are taxed as income under self-assessment. A sole trader pays fixed-rate class 2 national insurance contributions (NICs) plus class 4 NICs on their profits. A sole trader chooses an appropriate accounting period over which to compute their profits. For example, if a sole trader uses an accounting period ending 31st March, this normally means their profits are calculated over the 12 month period from 1st April to 31st March. It s possible to have accounting periods that are longer or shorter than 12 months and to change the end date. Example Accounting period ends Profits taxed in 31st March /19 31st December /20 The end of the sole trader s chosen accounting period determines the tax year into which their profits fall. A sole trader s relevant UK earnings for pension contributions in a tax year are their taxable profits for the accounting period which ends in that tax year. FINANCIAL PLANNING CONSIDERATIONS Legally this type of business ends with the sole trader s death. A new owner might be able to take over the assets and goodwill and continue to trade, but only as a legally distinct new business. Sole traders have no employer and need to consider their own life cover, income protection, critical illness benefits, private medical insurance and pension provision. Sole traders can use relevant life cover to provide any employees with death benefits, but aren t eligible for this type of protection themselves. Sole traders need to comply with automatic enrolment legislation if they have any employees or workers* for automatic enrolment purposes. Sole traders might need own life cover in relation to any business borrowing. If wanted, family protection trusts will usually be suitable as there s no legally distinct business to protect if they die or suffer a critical illness. Sole traders might want key person cover in relation to one or more employees which would involve a standard business protection solution. * Worker is an employment law status with more rights than traditionally self-employed people, but fewer rights than employees. 4

6 Section 1 Test your knowledge a) Identify four key characteristics of sole traders. b) The profits from a sole trader s accounting period running from 1st May 2017 to 30th April 2018 will be taxed in which tax year? i) 2019/20 ii) 2017/18 iii) 2018/19 iv) 2016/17 c) What difference does it make to setting up protection cover if a sole trader has business borrowing and their lender insists they (i) need to insure themselves (ii) need to insure an employee? 5

7 2. PARTNERSHIPS THIS SECTION COVERS THE MAIN TYPES OF PARTNERSHIP USED BY TRADING BUSINESSES ORDINARY PARTNERSHIPS, SCOTTISH PARTNERSHIPS AND LIMITED LIABILITY PARTNERSHIPS (LLPs). 6

8 PARTNERSHIPS An ordinary partnership involves two or more persons operating in business together. They jointly own and control the business. The persons can be living individuals or limited companies. It s possible for a partnership to include both individuals and companies, or to be made up entirely of limited companies. In England, Wales and Northern Ireland, a partnership isn t a separate legal entity distinguishable from the persons owning and managing it although the business might operate using a trading name. This means that all the partners or two or more formally designated partners must arrange any protection cover. The partners have unlimited joint and several personal liability for any debts and obligations incurred by their business. For example, if the partnership defaults on a business loan, the lender can demand full repayment from all or any one of the partners. There should always be a formal partnership agreement, setting out aspects such as profit shares and what happens if a partner dies. It s possible to operate in partnership with no formal agreement but default legislative provisions apply, which might conflict with the partners intentions. Partnerships often have employees. Some senior employees might use partner or salaried partner as their job title without being part owners of the business. They receive salary and other employee benefits subject to income tax and national insurance on a PAYE basis. SCOTTISH PARTNERSHIPS Scottish ordinary partnerships are separate legal entities in their own right. This means a Scottish partnership can take out protection cover on a partner or employee. In other key ways, they re treated in the same way as ordinary partnerships in the rest of the UK. The partners have unlimited liability. And each partner is taxed on a self-employed basis on their own share of the partnership s profits. LIMITED LIABILITY PARTNERSHIPS Like an ordinary partnership, a limited liability partnership (LLP) doesn t have any shareholders. It involves two or more persons operating in business together. These LLP partners are officially called members but are often referred to as partners. As with ordinary partnerships, they can include both living individuals and limited companies. LLPs must register with Companies House and comply with a range of legal requirements. It will use limited liability partnership or LLP in its business name. LLPs are separate legal entities in their own right. An LLP can take out protection cover on a partner/member or an employee. The main advantage of setting up an LLP instead of an ordinary partnership is that each partner s liability is restricted to the amount of capital they ve invested in the business. However, lenders normally require personal guarantees to support any business borrowing. PARTNERSHIP TAXATION The owners of an ordinary partnership wherever it s established in the UK take a share of the profits and are sometimes called equity partners. Individual partners are liable to income tax on their share of the profits on a self-employed basis and in the tax year in which the partnership s chosen accounting period ends. Each partner pays fixed-rate class 2 NICs plus class 4 NICs on their profit share. A partner s relevant UK earnings for pension contributions in a tax year are their share of the taxable profits for the accounting period which ends in that tax year. The tax treatment of individual LLP partners/members is generally the same as for ordinary partnerships. However, HMRC anti-avoidance provisions target disguised salary where the relationship between an LLP and an individual is effectively an employer/ employee one. Affected LLP partners/members are treated as employees for tax purposes with income tax and employer/employee NICs payable under PAYE. Corporate partners in both ordinary partnerships and LLPs are liable to corporation tax on their share of the profits see next section of this course. The tax treatment of any partnerships or LLPs involving a mix of individual and corporate partners can be complicated. The rules for calculating profits differ for the individual and corporate partners and anti-avoidance provisions apply. Therefore, it s always best to refer to the partnership or LLP s accountant for guidance. 7

9 Example Johnson Consultancy is structured as an ordinary partnership for tax reasons, but includes a limited company partner. The effective sole owner and only individual working in the partnership is Bill Johnson. Johnson Consultancy Partner 1 Partner 2 Bill Johnson Bill Johnson Consultants Ltd Director: Bill Johnson 100% shareholder: Bill Johnson If someone in this type of business structure needs protection cover, their adviser should refer to the business s accountant to establish the tax consequences depending on whether the partners collectively, the individual(s), or the company takes out the cover. FINANCIAL PLANNING CONSIDERATIONS Partners and LLP partners/members don t have an employer and need to consider their own arrangements for life cover, income protection, critical illness benefits and private medical insurance. Partners normally need to make their own pension provision. However, LLP partners/members may be covered by automatic enrolment. A partnership can use relevant life cover to provide its employees with death benefits. Self-employed partners and self-employed LLP partners/members aren t eligible for this type of cover. Partnerships and LLPs need to comply with automatic enrolment legislation if they have any employees or workers for automatic enrolment purposes. Automatic enrolment duties apply to LLP partners/members, although optional exemptions may apply. A partnership or LLP might need key person cover in respect of its partners/members or employees in connection with business borrowing or wider profit protection needs. Partnership protection can provide funds so that if a partner/member dies or wants to leave the business following a critical illness, the others can buy out their share of the business to retain control. It s also possible to use life cover to compensate a deceased partner s/member s family where an automatic accrual agreement is in place. 8

10 Section 2 Test your knowledge a) What are the key differences between ordinary partnerships and LLPs? b) Partners are normally taxed on a self-employed basis. Why must some LLP partners/members be taxed as employees? c) Who might you consider setting up relevant life cover for, if you re advising a partnership or LLP? And why? 9

11 3. COMPANIES THIS SECTION FOCUSES ON THE TWO TYPES OF COMPANY COMMONLY USED BY TRADING BUSINESSES PRIVATE AND PUBLIC LIMITED COMPANIES. 10

12 PRIVATE LIMITED COMPANIES A private limited company such as Example X Ltd is a legal entity in its own right. It can take out protection cover on its directors or any other employees. A private limited company is owned by its shareholder or shareholders and managed by its director or directors. It must register with Companies House and comply with a range of legal and HMRC requirements. For example, it must have at least one shareholder and at least one director. In addition, at least one director must be a living individual. It s common in small private limited companies for all the directors to be the same people as the shareholders. However, shareholders don t have to be directors and directors don t have to be shareholders. It s possible to have a one-person limited company an individual is the sole owner of the company as its sole shareholder. They can also be the company s only employee in their capacity as its sole director. The shareholders the business owners benefit from limited liability. Their risk is restricted to the money they ve invested in the company plus the remaining value of any partly paid shares they hold. However, lenders often require personal guarantees for business borrowing. So a shareholder or director could still be personally liable for repaying a business loan if the company defaults. A company s directors are its officers and are responsible for making decisions concerning the management of the business. They re company employees for income tax, national insurance and employer pension contribution purposes. Companies often have other employees. Some senior employees use director as a job title without actually being officers of the company. PUBLIC LIMITED COMPANIES A public limited company such as Example Y Plc is also a legal entity in its own right. It s able to sell its shares to the public, unlike a private company. This allows it to raise money by issuing shares or loan stock to fund its normal trading activities. It may be quoted on the stock exchange or the alternative investment market (AIM). There are more stringent legal, administrative and accounting requirements for public limited companies. These make their running costs considerably higher than for private companies. For example, a public limited company must have a suitably qualified company secretary and at least two directors, one of whom must be an individual. It must have at least two shareholders and have issued shares to the public to the value of at least 50,000. Otherwise, there are many similarities between private and public limited companies. In both types, shareholders enjoy limited liability but lenders can require personal guarantees from shareholders or directors. Both types pay corporation tax on the same basis. 11

13 COMPANY TAXATION The corporation tax rate is 19% for financial year 1st April 2018 to 31st March At the time of writing, it s planned to reduce to 17% from 1st April If a company s accounting period isn t aligned to the financial year and the corporation tax rate changes part way through its accounting period, its profits are apportioned on a days basis. Example Example Z Ltd has a 1st January to 31st December accounting period. Corporation tax reduced from 20% to 19% on 1st April Example Z Ltd made a profit in its 12 month accounting period ending 31st December It paid 20% corporation tax on 90/365ths and 19% corporation tax on 275/365ths of those profits. A company with profits of less than 1.5 million pays corporation tax nine months and one day after the end of its accounting period. Example Accounting period ends Corporation tax due 31st March st January st December st October 2019 A company with profits of 1.5 million or more pays corporation tax as quarterly payments on account. The first instalment is due 14 days after the end of the sixth month of the accounting period. The next three instalments are due at equal quarterly intervals after that. Example First quarterly payment Second quarterly payment Accounting period ends Third quarterly payment Fourth quarterly payment 14th October 14th January 31st March 14th April 14th July 14th July 14th October 31st December 14th January 14th April 12

14 SHAREHOLDER TAXATION A company pays dividends to its shareholders out of its after-tax profits. In 2018/19, individual shareholders get a 0% dividend allowance of 2,000, which uses up part of the income tax band(s) in which it sits. Any dividends in excess of this allowance are taxed at: 7.5% to the extent they fall into the basic rate band 32.5% if they fall into the higher rate band 38.1% if they fall into the additional rate band. These rates apply to all UK taxpayers, as the Scottish rates of income tax apply to non-savings, non-dividend income. Shareholding directors in owner-managed companies have tax-planning opportunities that aren t available to the self-employed or ordinary employees. A shareholding director often receives a salary at the level of the national insurance primary threshold, so they build up NICs qualifying years without any employer or employee NIC liabilities. They then receive the balance of their remuneration as dividends taxed at a lower rate than salary. Or they can receive a mix of dividends, salary and employer pension contributions. Any strategy involving dividends to avoid NICs should be discussed with the company s accountant, given HMRC scrutiny of some schemes. FINANCIAL PLANNING CONSIDERATIONS Directors are eligible for employee benefits including death in service and relevant life cover, income protection, critical illness benefits, private medical insurance and pension provision. A company can use relevant life cover to provide employee death benefits to its directors as well as any other employees. A company needs to comply with automatic enrolment legislation for any employees and workers for automatic enrolment purposes. Exemptions and optional exemptions apply to company directors. A company might need key person cover in respect of its directors or employees in connection with business borrowing or wider profit protection needs. Shareholder protection can provide funds so that if a shareholder dies or wants to leave the company following a critical illness, the other shareholders can buy out their shares to retain control. It s also possible to use life cover in connection with company own-share purchase in these situations. 13

15 Section 3 Test your knowledge a) What are the roles of (i) a company s directors and (ii) its shareholders? b) What s the tax status of a company s directors? c) What s the role of shareholder protection? 14

16 4. APPENDIX LOAN PROTECTION EXAMPLES To support your learning, the following table illustrates how the different types of trading business covered in this course might meet a loan protection need. For further information on business protection needs, see the Business protection keyperson, shareholder and partnership protection CPD course. Type of business Business/Borrowing basis Lender s requirements Cover basis Sole trader Amy James trading as A J Bookkeeping Amy takes out a business loan Lender requires Amy to take out life cover as a condition of the loan Amy sets up an own life policy for the lender s required sum assured and term Ordinary partnership Amy James and Christine Curtis in partnership as A & C Bookkeeping Amy and Christine, the partners, take out a business loan Lender requires Amy and Christine to take out life cover It might require both of them to be insured for the full amount as they ll have joint and several liability for repaying the loan Amy and Christine each set up an own life policy Or, Amy and Christine each set up a life of another policy on the other s life Scottish partnership Amy James and Christine Curtis in partnership as A & C Bookkeeping Partnership takes out a business loan Lender requires A & C Bookkeeping to take out life cover for Amy and Christine As above, it might require both of them to be insured for the full loan amount Scottish partnership sets up two life of another policies one on Amy s life and one on Christine s Limited liability partnership Amy James and Christine Curtis members of A & C Bookkeeping LLP LLP takes out a business loan Lender requires A & C Bookkeeping LLP to take out life cover for Amy and Christine As above, it might require both of them to be insured for the full loan amount LLP sets up two life of another policies one on Amy s life and one on Christine s Limited company Amy James sole shareholding director of A J Bookkeeping Ltd Lender requires A J Bookkeeping Ltd to take out life cover for Amy Company sets up a life of another policy on Amy s life Company takes out a business loan 15

17 ANSWERS TO SECTION QUESTIONS 1a) A sole trader is in business on their own account their business has no separate legal identity. A sole trader has unlimited liability for their business debts and obligations. A sole trader is self-employed. A sole trader can have employees. 1b) iii) 2018/19 1c) If the sole trader needs to insure themselves in respect of business borrowing, it s likely that a family protection trust will be suitable. If they need to insure an employee, it s likely that a standard business protection solution will be suitable. 2a) Partners in ordinary partnerships have unlimited liability while an LLP s owners benefit from limited liability. Ordinary partnerships are not separate legal entities except in Scotland while all LLPs are separate legal entities. 2b) Targeted anti-avoidance legislation means that if the relationship between an LLP and a partner/member is deemed to be an employer/employee one, the individual is taxed on an employee basis. They re taxed under PAYE and employer plus employee NICs are payable. 2c) A partnership or LLP s employees its self-employed business owners aren t eligible. If the partnership or LLP wants to offer its employees death in service benefits. 3a) A company s directors are its officials with responsibility for its management. A company s shareholders are its owners they own shares in the company and benefit from limited liability. 3b) Company directors are employees for income tax and NICs purposes. 3c) Shareholder protection provides funds for the other shareholding directors to buy out a deceased shareholder s shares or a critically ill shareholder s shares if they wish to leave the business. This allows the remaining shareholders to keep control of the business. It s also possible to fund for company own-share purchase. 16

18 Scottish Widows Limited. Registered in England and Wales No Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number (UBS) 10/18