SQE 1 - Business Law (Starting a new business)

What is the difference between an unincorporated business and an incorporated business?

An incorporated business has its own legal entity or separate personality.

It needs to be registered on with Companies house.

It is an artificial person created by law and legally distinct from those who run the business.

In contrast an unincorporated business is not a sperate legal entity.

What is an unincorporated business?

An unincorporated business does not have its own legal entity (or separate personality). There is no legal distinction between the business and it's owner(s) and manager(s).

What is a corporated business?

An incorporated business has its own legal entity (or separate personality). There is a legal distinction between the business and its owner(s) and manager(s)

Niamh is the only director and shareholder of a private limited company. The company has entered into a contract with your client, Linda, and failed to perform its obligation.

Should Linda consider legal action against Niamh, the limited company or both?

Linda should only consider legal action against the limited company. As a separate (artificial) legal person, it owners the contractual obligations to her.

What are the different types of unincorporated businesses?

1. Sole traders

2. Partnerships

What is a sole trader/ business?

A sole trader is a person who self-employed and runs their own incorporated business.

They may have employees, but they are the sole owners.

What is a sole proprietor?

In essence this is the same as a sole trader, but this term is sometimes used for individuals who have a profession (e.g. a dentist) rather than a trade (e.g. a shop owner)

What are the pros of being a sole trader?

1. As an unincorporated business, there is no legal separation between the business and the sole trader's personal affairs/assets. Therefore, they are entitled to keep all profits after tax

2. There are no specific formalities or legal processes required to set up the business. This avoids the additional cost of forming a company. Being a sole trader is more attractive, private and less expensive.

What are the cons of being a sole trader?

1. Sole traders are subject to unlimited liability

Do sole-traders have to register with HMRC and VAT?

1. Sole traders must register with HMRC

2. Some sole traders are required to register for VAR.

What is unlimited liability?

Unlimited liability means that the business owner(s) are personally and directly responsible for all of the debts and liabilities the business incurs, no matter what the value.

Therefore, their personal assets (e.g. their properties, money held in bank accounts, even if unrelated to the business) will be at risk and they can be made bankrupt if the business is unsuccessful.

Katrina set up a business as a hairdresser several years ago, but the liabilities of the business now exceed its assets by over £100k. Katrina has savings of £50k and a house worth £200k. The realisable assets of the business to £20k.

How would you advise Katrina?

As a sole trader, Katrina will be personally liable for the debts of the business. The business is unincorporated, so does not have its own legal entity (or separate personality). There is no legal distinction between the business and its owner/manager. Therefore, Katrina's personal assets will be at risk (including her home) if she is unable to satisfy the debts of the business.

How do sole traders pay tax?

Sole traders pay income tax on their trading profits and capital gains tax on their capital gains.

They will usually obtain tac advice when deciding on the type of business medium to adopt.

Rylan wants to set up his own business as a window cleaner. His funds are modest and his liabilities and financial investment will be low. He is keen to keep things simple and not to incur substantial expense.

How would you advise Rylan with regard to the most suitable business medium for him?

Although the benefits of limited liability may be significant for those investing in large sums and taking significant risk, it would appear that the costs and administrative burden or setting up a limited company would not be appropriate here. Therefore, in this situation, it would be advisable for Rylan to operate his business as a sole trader.

What is a parternship?

A partnership is an unincorporated business with at least two owners.

Two or more people 'carry on' a business sin common with a view of profit (s 1 Partnership Act 1890)/

Even if the partnership has employees, partners are the owners of the business.

Determining a partnership is a matter of fact, it arises when two or more persons actually carry on a business in common with a view of profit.

Netta and Duncan are friends. They make and sell cakes in town where they live and split the money they receive 50-50. They think that, as the arrangements are purely informal and there is nothing in writing this is not a partnership.

Is this correct?

No.

They are mistaken. Netta and Duncan are 'carrying on a business in common with a view of profit', this is how a partnership in s1 Partnership Act. There is clearly an agreement between the parties (whether oral or implied by conduct) as to how the business is run.

Are there formalities required to set up a partnership? (split into more flashcards)

No.

Similar with sole traders, no specific formalities are required to set up the business.

Partnership can arise through oral agreement or conduct. As long as 2 or more parties are carrying on business with a view of profit, a partnership exists.

What are the pros of a partnership?

1. Management is more straightforward then with companies - There is no separation of ownership and control (s5 PA). Every partner may act for the purposes of the partnership business and the acts of any one partner may bind the partnership.

2. The additional costs of forming a company are avoided.

3. There is no onerous ongoing formality, decision-making, filing and disclosure requirements, in contrast to companies. This makes partnerships more attractive, private and less expensive.

Is it desirable to have a formal partnership agreement?

It is often desirable to have a formal partnership agreement, setting out the terms of the partnership. This is because the provisions of the Partnership Act, apply in the absence of an express or implied agreement ('default provisions'. Many of the default provisions can have undesirable consequences.

What are the cons of a partnership?

Disadvantage → partners have unlimited liability.

Do partnerships have to register with HMRC and VAT?

1. All partnerships must register with HMRC

2. Some partnerships must register with VAT (search which ones)

How do partners pay tax?

Individual partners pay income tax on their share of the trading profits and capital gains tax on their share of the capital gains for the partnership.

What is the distinction between partnerships and limited liability partnerships under the Partnership Act?

LLPs must be registered.

They are able to grant Floating charges and Debentures.

What are the different types of incorporated businesses?

1. Companies

2. Limited liability partnerships

What is a company?

A company is an incorporated business with separate legal personality, and where the owners (members) can/usually have limited liability.

The company may be limited by shares or by guarantee and can be public or private.

A company is the creation of legal processes and documents that must be filed at Companies House in order for the company to be born.

What are two key characteristics of a company?

1. Separate legal personality

2. Limited liability

What is the principle of separate legal personality?

The company is a person separate from its members/shareholders and directors. As a separate legal person, it can own property, enter into contracts and be a party to legal proceedings (being sued or suing).

It can have perpetual succession (i.e it can continue indefinitely)

Saloman v Saloman & Co.

Separate legal personality

The courts held that it was not fraud to set up a limited company in order to create a separate legal personal, to avoid personal responsibility for debts.

There are rare cases where the courts will disregard this principle and impose personal liability (Prest v Petrodel Resources Limited) - check SQE spec to see if this is tested,

What is the difference between a company, in contrast to sole traders/partnership? (re-word this question)

Unlike sole traders and partnerships, a company is not the agent of its shareholders (not even a one-person company with one director and one member/shareholder).

The company acts in its own right and not simply on the behalf of its owner.

The basic company model distinguishes between the shareholders/members and the directors.

What are company shareholders?

The shareholders own the shares in the company. Shareholders are also referred to as 'members'.

What are company directors?

The directors have general management power to control what the company does of a day-to-day basis. They run the company.

Can shareholders and directors be the same people?

Yes, this often happen with smaller companies.

What are the pros of a company?

1. Separation between membership (ownership) and management.

2. The sale/transfer of a company or any interest in it is straightforward as this can be done through the transfer of shares as an alternative to the transfer of the assets themselves.

What are the cons of a company?

1. The separation of membership (ownership) and management can b cumbersome for smaller businesses (e.g. one member, one director)

What is limited liability?

Limited liability means that members have a limit on their liability to contribute towards the company's debts.

How can liability be limited?

1. Limited by shares (this is more common) - the liability of members (shareholders) is limited to any amount unpaid on their shares

2. Limited by guarantee (this usually occurs for non-profit making entities) - the liability of members is limited to any amount they promise to pay in the event that the company is wound up (ie when the company is brought to an end and ceases to exist)

Kobi subscribes and pays for 100 £1 shares in a private limited company. The company is subsequently wound up.

What is Kobi's liability?

Kobi will have no further liability as he held fully paid shares. Had payment no been made, or only partially made, he would be liable for he full balance of the unpaid shares.

How do companies pay tax?

Companies pay corporation tac on both their income profits and their capital gains.

What are the differences between a public and private company?

Picture of grid in phone

What is a limited liability partnership?

LLPs are a cross between a company and a partnership, formed under the Limited Liability Partnership Act 2000.

They are a type of incorporated business.

What are the features of LLPs?

1. They are available for persons 'carrying on a lawful business with a view of profit' - s1(1)(a) LLPA and every member is deemed to be an agent of the LLP s6 LLPA

2. When registered at companies house, an LLP is a separate personality s1(2) LLPA and members gave limited liability/are not directly responsible for its debts (s 1(4) and (5) LLPA

3. Similar to companies, LLPs may grant fixed and floating charges over their assert.

4. LLPs are subject to ongoing administrative and reporting requirements.

What is a con of LLPs?

LLPs are not as well recognised internationally as companies.

How do LLP members pay tax?

LLP members pay income tax on their share of the trading profits and capital gains tax on their share of capital gains for partnership.

How is a LLP created?

By sending form LLIN01 to Companies House