Starting up a business of your own is a big step and not one to take lightly. The taxation of your business is only one of many commercial and legal aspects of starting a business that you will need to consider.
Preparation is the key and a proper business plan is one of the first things you should do.
However, tax matters are our main concern here.
Choosing a business structure
The alternative business structures are:
This is the simplest form of business structure since it can be established without legal
The business of a sole trader is not distinguished from the proprietor’s personal
affairs. If the business incurs debts which are unpaid, the creditors can seek repayment from the sole trader personally.
A partnership is similar in nature to a sole trader but involves two or more people
working together. A written agreement is essential so that all partners are aware of the terms of the partnership. Again, the business and personal affairs of the partners are not legally separate.
Sole traders and partnerships are often referred to as unincorporated businesses and
the individual owners as self-employed.
A company is a legal entity in its own right, separate from the personal affairs of the
owners and the directors.
A company provides protection from liability, which means that the creditors of the company cannot make a claim against the owners or the directors except in limited circumstances.
Often this advantage is somewhat eroded because a bank, for example, may seek
personal guarantees from the directors. These potential advantages carry the
downside of greater legal requirements and regulations that must be complied with.
Limited Liability Partnerships (LLPs)
LLPs are a halfway house between partnerships and companies.
They are taxed in the same way as a partnership but are legally a corporate body. This again gives some protection to the owners from the partnership’s creditors.
In this guide we consider the differing tax treatments of the alternatives but you should
choose which structure is right for you based on more than just the tax issues alone.
The tax regime
A new business should register with HMRC on commencing to trade. Income tax is paid on the profits of the business. The amount that the proprietor, or a partner in a partnership, draws out of the business (referred to as ‘drawings’) is irrelevant.
Profits are taxed on a current year basis as shown by the example, although a new
business will be subject to special rules, which we will be pleased to explain to you.
Example: If the accounting period (or ‘year’) end is 31 March then, in the tax year 2019/20, the profits for the year ended 31 March 2020 will be taxed. If the year end was 31 August then, in the tax year 2019/20, the profits for the year ended 31 August 2019 will be taxed.
Tax Tip: The choice of accounting date on a business start up can affect:
- how profits are taxed
- when tax is payable
- when losses are relieved.
Working out profits
Profits are calculated using accepted accounting practices and crucially this means
that profit is not necessarily simply receipts less payments. Instead it is income earned less expenses incurred. However see details of the optional cash basis for smaller unincorporated businesses.
Not all of the expenses that a business incurs are allowed to be deducted from income for tax purposes but most are. It is important that you keep proper and comprehensive business records so that relief may be claimed.
Tax Tip: Try to incur expenditure just before rather than just after the year end, as this willaccelerate the tax relief. Examples of the type of expenditure to consider bringing forward include building repairs and redecorating, advertising, marketing campaigns and expenditure on plant and machinery.
Trading and property income allowances
Trading and property income allowances of £1,000 per annum are available. Individuals
with trading or property income below £1,000 do not need to declare or pay tax on that income. Those with income above the allowance are able to calculate their taxable
profit either by deducting their expenses in the normal way or by simply deducting the relevant allowance.
Cash basis for smaller unincorporated businesses
An optional basis for calculating taxable profits is available to small unincorporated
businesses. If an owner of a business decides to use the cash basis, the business profits
would be taxed on cash receipts less cash payments of allowable expenses subject to a
number of tax adjustments.
The optional scheme requires an election by the business owner and is only available where the business receipts are less than £150,000. Businesses can stay in the scheme up to a total business turnover of £300,000 per year.
Further details about the scheme:
- Cash receipts include all amounts received in connection with the business including those from the disposal of plant and machinery. The good news is that if a customer has not paid what is owed by the year end, the amount due is not taxable until next year.
- Allowable payments include paid expenses but these still need to meet the existing tax rule of being wholly and exclusively incurred for the purposes of the trade.
- Payments include most purchases of plant and machinery, when paid, rather than claiming capital allowances. The bad news is that if a supplier is not paid by the year end, the amount is not relievable until next year.
- Interest payments are only allowed up to a limit of £500.
- Business losses may be carried forward to set against the profits of future years but not carried back or set off ‘sideways’ against other sources of income.
When assets are purchased for the business, such as machinery, office equipment or motor vehicles, capital allowances are available. As with expenses, these are deducted from income to calculate taxable profit.
Plant and machinery - Annual Investment Allowance (AIA)
The AIA from 1 January 2019 gives a 100% write off on most types of plant and machinery costs, but not cars, of up to £1,000,000 per annum (£200,000 from 1 January 2016 to 31 December 2018). Special rules apply to accounting periods which straddle these dates. Any costs incurred in excess of the AIA will attract an annual ongoing allowance of 6% (8% before April 2019) or 18% depending upon the type of asset.
Other allowances include a 100% allowance on certain energy efficient plant and low
emission cars and a 2% Structures and Buildings Allowance.
The tax allowance on a car purchase depends on CO2 emissions. Currently purchases of cars with emissions of up to 110g/km attract an 18% allowance and those in excess of
110g/km are only eligible for an 6% allowance (8% before April 2019).
Paying the tax
The self-employed may have to pay tax and NICs three times a year, namely:
- 31 January in the tax year
- 31 July following the tax year
- 31 January following the tax year.
In certain circumstances, the first two payments can be waived.
As an employer you will have many responsibilities. These will include employment law requirements which are not covered in this guide and HMRC requirements to report pay and benefits. Two other requirements place a further burden on employers.
Real Time Information
Real Time Information (RTI) reporting is mandatory for broadly all employers.
Under RTI, employers or their agents, are required to make regular payroll submissions
for each pay period during the year. The submissions detail payments made to and
deductions made from employees. These submissions must generally be made on or
before the date the amounts are paid to the employees.
The RTI submission details payments made which include salary, overtime and statutory
payments such as statutory maternity pay. It also details the income tax, national insurance contributions (NICs) due together with other deductions such as student loan repayments.
The PAYE and NICs on salaries is payable monthly (or quarterly where the amount due is less than £1,500 per month).
Penalties apply to employers who fail to make returns on time. These penalties range from £100 to £400 per month depending on the size of the employer. Interest and penalties also apply for failing to pay on time.
The employer must also report details of expenses and benefits provided to employees.
Pensions Auto Enrolment (AE)
AE obliges on employers to automatically enrol ‘workers’ into a work based pension
scheme. Duties include:
- assessing the types of workers in the business
- providing a qualifying automatic enrolment pension scheme
- automatically enrolling all ‘eligible jobholders’ into the scheme and
- paying employer contributions.
All employers generally need to contribute at least 3% of the ‘qualifying pensionable
earnings’ for eligible jobholders from 6 April 2019.
If the employer only pays the employer’s minimum contribution, employees’
contributions are generally 5% from 6 April 2019 to meet the overall minimum 8%
contribution rate. There are different ways of calculating minimum contributions and
the employee contributions may be paid net of basic rate tax depending on the type of
Practical Tip: All employers have to comply with Auto Enrolment from when they first take on an employee. We can help you to deal with Auto Enrolment.
Unlike sole traders and partnerships who pay tax on profits only (and drawings are ignored), companies have two layers of tax. The first is tax payable by directors and shareholders on money they take out of the company and the second is corporation tax which is due on the company’s profits
Practical Tip: If you operate as a limited company, there is a legal separation between you as the owner and the company itself. This means you cannot use the company bank account as if it were your own! This requires a certain amount of discipline without which all kinds of legal and tax related difficulties can occur.
Companies currently pay corporation tax at 19%.
Tax on ‘drawings’
Directors of a company will normally be paid a salary and this is taxed under PAYE as for
all employees. The cost of this, including the employer’s NICs, is generally an allowable
expense of the company. Shareholders of the company in contrast may be rewarded by the payment of dividends on their shares.
Tax Tip: In most small companies the directors and shareholders are one and the same and so they can choose the most tax efficient way to pay themselves. Using dividends can result in savings in NICs. This requires planning and needs to take account of the Dividend Allowance, which taxes dividends within the allowance at 0%, and dividend rates of tax. The Dividend Allowance remains at £2,000 for 6 April 2019 so careful planning is required.
Warning - close company loans to participators
A close comp any (which generally includes owner managed companies) is taxed in certain circumstances when it has made a loan or advance to individuals or their family members who have an interest or shares in the company (known as participators). The tax charge is currently 32.5% of the loan if it is outstanding nine months after the end of the accounting period. The tax charge is repaid to the company nine months after the end of the accounting period in which the loan is repaid.
Further rules prevent the avoidance of the charge by repaying the loan before the nine
month date and then effectively withdrawing the same money shortly afterwards.
A ‘30 day rule’ applies if at least £5,000 is repaid to the company and within 30 days new
loans or advances of at least £5,000 are made to the shareholder. The old loan is effectively treated as if it has not been repaid. A further rule stops the tax charge being avoided by waiting 31 days before the company advances further funds to the shareholder. This is a complex area so please do get in touch if this is an issue for you and your company.
Planning Tip: Ensure that sufficient salary and dividends are drawn from the business to prevent these charges arising unnecessarily on an overdrawn director’s current account. We can also ensure that overdrawn accounts are cleared properly.
Tax on profits
The profits of a limited company are calculated in a similar way as for unincorporated
businesses and the same rules with regard to expenses and capital allowances generally
apply. Remember though that the salaries paid to directors, but not the dividends paid to
shareholders, are deductible from the profits before they are taxed.
Tax Planning: Companies are a popular business structure as they generally result in less tax being paid overall. We would be happy to discuss the implications of incorporation with you before you decide whether or not to incorporate your business.
Payment of tax
Corporation tax is usually payable nine months and one day after the year end, so the choice of accounting date has no tax consequence.
Practical Tip: HMRC issues toolkits on various tax topics to help taxpayers and their agents comply with tax law. One of the main areas of non compliance identified by HMRC is poor record keeping and this applies to all types of business. If you would like guidance on what records to keep please get in touch.
Over recent years, many families have been attracted by the savings that can
be made by combining small salaries and large dividends. It was possible
to increase the savings available by introducing a non-working family member
into the business as a shareholder or coowner, to use up their personal allowance
and lower rates of tax.
Care needs to be taken as rules aimed at counteracting this in the ‘settlements
legislation’ could be used to challenge certain arrangements.
To find out more or discuss any of the points raised above, please contact us.