10 Common Questions About UK Tax for Small Business Owners
In this world nothing can be said to be certain, except death and taxes. Benjamin Franklin
No matter how confused we are about tax, the truth is it's unavoidable. Burying your head in the sand or not answering the phone isn't going to make the taxman go away!
You need to be on the ball with the tax legal requirements and identify (legal!) ways to save money and maximize credits and deductions.
Being the owner of a small business is amazing. If you're doing it, chapeau to you. Along the way, you've no doubt had questions about tax.
Worry no more, we've got you covered with answers to 10 common tax-related questions for small business owners in the UK!
Before we kick off, I'd like to give a massive thanks to the awesome team of tax specialists at Ridgefield Consulting, Oxford’s leading firm of Chartered Accountants & Business Advisors, for their help compiling these answers. If you're looking for a team of specialists to help take the stress of managing my accounts away, then look no further, contact Ridgefield Consulting today!
Ok, let's dive in to find the answers to these 10 common questions about UK tax for small business owners!
1. What taxes do sole traders have to pay?
All self-employed people (which include sole traders and partners in a business partnership) must pay 2 things:
national insurance contributions.
What is Income Tax?
Income tax is the tax you pay on your earnings.
Once your earnings go above your personal allowance you must start paying tax. How much Income Tax you pay in each tax year depends on how much of your income is above your Personal Allowance and how much of your income falls within each tax band.
The standard Personal Allowance for the tax year 2021/22 is £12,570, which is the amount of income you do not have to pay tax on.
Income tax rates vary, and how much you pay depends on which of the income tax brackets you fall into.
What are the income tax rates for the tax year 2021/22?
Basic rate tax is payable at a rate of 20% on taxable income between £12,570 and £50,270
Higher rate tax is payable at a rate of 40% on taxable income between £50,271 and £150,000
Additional rate tax is payable at a rate of 50% if you earn more than £150,000
What is National Insurance?
National Insurance (NI) is a specific type of tax that helps fund certain benefits such as the NHS, maternity, sick and bereavement pay, and the state pension.
Contributions need to be made by individuals so that they are entitled to receive such benefits. NI contributions need to be paid from the profit made if you are self-employed and is paid through your self-assessment tax return.
As a sole trader, you will pay National Insurance if you’re 16 or over and self-employed and making a profit of £6,515 or more a year (2021/22). You need a National Insurance number before you can start paying National Insurance contributions. Self-employed individuals are liable to class 2 and class 4 National Insurance.
Both income tax and national insurance are calculated through your self-assessment tax return which must be filed once a year.
The UK financial tax year runs from 6 April to the following 5 April and this is the period you will need to account for when completing your tax return.
Filing and paying for your tax return is due by midnight 31 January the following year.
For example, if you are completing a tax return for the tax year 6 April 2020 to 5 April 2021, both the tax return and payment must be completed by 31 January 2022.
2. What taxes do limited companies have to pay?
All limited companies must pay corporation tax, VAT if you're a VAT registered company and National Insurance if you employ staff.
Corporation tax is paid by UK limited companies and some other organizations. It is based on the annual profits that a company makes. All profits are taxable however, certain specific expenses can be deducted, and there are allowances you can make use of to help reduce your tax liability.
The corporation tax main rate in the UK is set at 19% for all business profits. The rate will remain at this level for the next 2 years.
The corporation tax filing deadline is different to other taxes. It must be paid before you file your company tax return. This means the date it needs to be paid depends on your corporation tax accounting period. You must settle your corporation tax bill nine months and one day after the end of your accounting period from the previous financial year. If your accounting period ends 31 December, then your bill will be due on the following 1 October.
Only limited companies which are VAT registered must pay VAT.
Value-added tax, or VAT as it is more commonly referred to, is a consumption tax charged in the UK. It is paid for by all consumers and collected by VAT registered businesses who must then pass this tax collection onto HMRC. VAT accounts for being the third biggest income generator for the UK government, after income tax and national insurance contributions. Together, all three raise over half the government’s total tax receipts.
VAT is described as a form of consumption tax because it is applied to almost all products and services you would use.
However, it is not always clear when you have been charged VAT, on what, and how much because there are different rates of VAT that apply depending on the type of item or service.
In the UK, VAT operates under 3 different rates:
Finally, there is also a distinction between zero rated items and goods and services which are exempt from VAT altogether.
When you are a VAT registered company you need to make sure that you are keeping on track of your VAT payments and that you pay on time.
There are 12 months in your VAT accounting period. Your VAT Return is due once a year, 2 months after the end of your accounting period. Most businesses now need to keep digital VAT records and use software to submit VAT Returns.
If your limited company employs staff, you will also have to pay employer national insurance contributions.
Employers' National Insurance is a type of Class 1 National Insurance that employers must pay to HMRC in respect of their employees' wages. The Employers pay 13.8% on every pound the employee earns over £9,568 per year in 2021-22.
3. Do small businesses get tax refunds?
Small businesses are entitled to tax refunds when they have overpaid on tax and limited companies can claim back overpaid tax with interest, depending on circumstances.
As with a self-assessment tax return for self-employed individuals, business organizations can indicate overpayments on their company tax returns.
The HMRC interest rate is 0.5% on overpaid corporation tax. This is applied when your business has either paid tax early or paid more than is owed.
HMRC pays interest covering the period starting from the corporation tax payment up until the payment deadline.
Interest is calculated starting either from the date when the tax was due, or when the tax was paid.
If your company pays tax in quarterly instalments, interest is calculated either from the first instalment date or the date that the balance goes above what is owed.
It’s important to note that these interest payments are taxable and should be included as income in your next company tax return.
As with PAYE and self-assessments, you have several options for claiming overpaid corporate tax.
Provide your business account number and sort code on the tax return for direct payment into your company bank account.
Use your overpayments to help offset your next corporation tax bill or late filing penalties.
Use the overpayments to offset other taxes owed by the company, such as PAYE or VAT.
4. Do small businesses pay Corporation Tax?
Only small businesses which operate as a limited company need to pay corporation tax.
Any business that is set up as a limited company must pay corporation tax on its profits both from trading and from the sale of investments or assets. You'll need to register for this tax when you set up as a limited company (within three months of starting to trade).
Every business, no matter how big or small, needs a legal structure and must pay tax in one form or another. You can choose to be either a sole trader, partnership, or limited company and most choose to be either a sole trader or a limited company.
You will need to weigh up the difference between a sole trader and a limited company, as the structure you choose could impact everything from profits to paperwork.
Don’t rush into any decision and speak to an accountant if you’re unsure, as their expertise is often invaluable when it comes to tax.
5. How much do you have to earn before you pay Corporation Tax?
There is no limit to how much you have to earn before you must pay corporation tax as long as your business is making a profit.
Corporation Tax is essentially an income tax for companies, but the difference is that companies don’t have a personal allowance. This means that as soon as your business starts making a profit, you needs to start paying Corporation Tax at the 19% rate (unless it’s previously made losses).
If you are operating at a loss, you will not have to pay any corporation tax, but you will however still be required to notify HMRC of this fact and you must still file your company annual accounts.
6. How do you calculate Corporation Tax?
To calculate corporation tax, there are a few steps you have to go through.
Calculate sales and income
Calculate overheads and claim on all allowable expenses
Calculate capital allowances and depreciation
Calculate entertaining costs
Calculate corporation tax @19% of profit
Let's look at these steps in a bit more detail.
Step #1 - Calculate sales and income
To kick off, you first need to calculate sales and income.
To do this you will need to start by creating a profit and loss account. This should total up all sales income your business generates as well as any interest earned such as in a corporate savings account.
For example, your business generates sales of £150,000 and interest of £200 on money stored in a business bank account.
This would give you a total income of £150,200.
Step #2 - Calculate Overheads + Claim on All Allowable Expenses
After you have calculated your total income, you will need to calculate overheads.
Overheads and other business expenses can be deducted from your trading income to arrive at the profit your business makes.
To make sure you are not paying more than you need to, make sure you claim all allowable expenses. Expenses usually include things such as accounting fees, postage and packaging, salaries, insurance, travel and office costs. For example, let’s say your total overhead came to £43,675.
Step #3 - Calculate Capital Allowances and Depreciation
Once both total income and overheads have been calculated you will need to work out your capital allowances and depreciation.
Capital allowances are expenses that your business incurs buying fixed assets that will be part of your business for several years, such as computing equipment and furniture. Over time the value of the asset will decrease.
For example, you buy a computer for £1,500 and over 3 years this will depreciate so that the asset has a value of £0. Depreciation is not an allowable expense, so it needs to be added back into the tax calculation.
For most small business corporation tax calculations, most capital asset purchases will qualify for Annual Investment Allowance Tax Relief. This means that up to £200,000 of capital costs each year are effectively written off and can be used to reduce the amount of profit liable for corporation tax.
Step #4 - Calculate Entertaining Costs
Entertaining costs will also need to be considered when working out how much corporation tax is due.
Costs associated with entertaining clients and suppliers such as business lunches, trips to sporting events, gifts and free samples are not tax-deductible; you can’t claim either tax relief or VAT on the costs of entertaining.
Step #5 - Calculate your Corporation Tax Bill
Finally, you use all the calculation you have previously worked out to calculate your Corporation Tax bill.
For example, let’s assume that £1,500 was spent on capital equipment in the year, which will depreciate at £500 a year over three years, and £1000 on entertaining clients.
To calculate corporation tax you would add back any depreciation and client’s entertaining costs to the profit before accounts total, then subtract any capital allowances to arrive at the profit value that is liable for Corporation Tax.
Here's an example to illustrate:
7. How often do you have to pay Corporation Tax?
You normally only need to pay corporation tax once a year. The exception to this may be in your first year of incorporation as your first accounts usually cover more than 12 months.
This is because your accounts start on the day your company was set up or end on the ‘accounting reference date’ that Companies House sets for the end of your company’s financial year this is the last day of the month your company was set up.
For example, if your company was set up on 11 May, its accounting reference date will be 31 May the following year. So, your company’s first accounts must cover 12 months and 3 weeks. In the following years, your accounts will normally cover your company’s financial year from 1 June to 31 May.
The period covered by your tax return (your ‘accounting period’ for Corporation Tax) can’t be longer than 12 months. So, you may have to file 2 tax returns to cover the period of your first accounts. If you do, you’ll also have 2 payment deadlines.
In the following years, you will normally only file one tax return and it will usually cover the same financial year as your annual accounts.
8. How can a small business reduce its Corporation Tax bill?
Small business owners who operate through a limited company will likely be aware that Corporation Tax is only paid on the profits made through the company.
However, not all business expenses are tax-deductible and so, although you may incur legitimate expenses running your business, for the purpose of completing your company tax return and paying Corporation Tax, some of those expenses will be added back on as profit.
Nevertheless, there are still plenty of expenses that you should ensure you are claiming for which will reduce your corporation tax bill, as well as tax relief you may be able to claim.
Here are 5 ways to reduce your corporation tax bill:
Pay HMRC Early
Directors should take a salary
Celebrate and reward staff with annual events
Claim travel mileage
Use a company mobile phone
Check out this article from Ridgefield Consulting for more ways to reduce your corporation tax. Happy days!
9. How can you get the Small Business Rate Relief?
Small business rate relief is aimed at helping small businesses where they are not entitled to another mandatory relief. You can get small business rate relief if you only use one property, or your property rateable value is less than £15,000.
Small business rate relief will mean you will not pay business rates on a property with a rateable value of £12,000 or less.
For properties with a rateable value of £12,001 to £15,000 the rate of relief will go down gradually from 100% to 0%.
For example, if your rateable value is £13,500, you’ll get 50% off your bill. If your rateable value is £14,000, you’ll get 33% off.
To apply for small business rate relief, you will need to contact your local council.
10. How much National Insurance do I pay as a limited company?
To recap, National Insurance (NI) is a specific type of tax that helps fund certain benefits such as the NHS, maternity, sick and bereavement pay, and the state pension.
Contributions need to be made by individuals so that they are entitled to receive such benefits. If your business employs people, you'll need to pay the employer's portion of National Insurance contributions directly to HMRC.
Businesses must pay 13.8% in National Insurance Contributions (NICs) for employees with earnings above £9,568 per year in the tax year 2021-22.
However, you may be able to reduce your NICs by up to £3,000 if the business is eligible for the Employment Allowance. This was launched in April 2014 to help small businesses recruit more staff. From April 2020, only organizations with NICs of less than £100,000 will be eligible. In addition, if you're employed by your limited company, your National Insurance contributions will be taken automatically through payroll.
We hope this helps give you some answers to 10 common questions about UK tax for small business owners!
Are there any other questions that we've missed?
A final word of thanks to the team at Ridgefield Consulting for their help with this article, and get in touch with them if you need any further tax advice!
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