Working for Yourself
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 should be 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:
Sole Trader
This is the simplest form of business since it can be established without legal formality.
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.
Partnership
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.
Limited Company
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 section 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
Unincorporated businesses
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 can outline for you.
Example
If the accounting period (or ‘year’) end is 31 March then, in the tax year 2010/11, the profits for the year ended 31 March 2011 will be taxed.
If the year end was 31 August then, in the tax year 2010/11, the profits for the year ended 31 August 2010 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
So do contact us to discuss the options available for your circumstances.
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.
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 will accelerate the tax relief.
Examples of the type of expenditure to consider bringing forward include building repairs and redecorating, advertising and marketing campaigns and expenditure on plant and machinery.
Capital allowances
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. There have been recent major changes to the regime.
Plant and machinery - Annual Investment Allowance (AIA)
The AIA was introduced for expenditure incurred on or after 6 April 2008 (1 April 2008 for companies) by all businesses.
It gives a 100% write off on most types of plant and machinery costs, but not cars, of up to £100,000 per annum. The limit was £50,000 for expenditure incurred before 6 April 2010 (1 April 2010 for companies). Any costs over the AIA will attract an annual ongoing allowance of 10% or 20% depending upon the type of asset.
The AIA may need to be shared between certain businesses under common ownership.
The AIA will be reduced to £25,000 with effect from April 2012. Additionally, the annual ongoing allowances will be reduced to 8% or 18% depending on the type of asset. Capital expenditure plans should therefore be reviewed to consider maximising available tax relief.
The following table demonstrates the income tax relief that would be obtained by a self employed 40% tax payer on differing levels of qualifying main pool plant purchases in the tax year of expenditure.
Expenditure |
Tax saving if expenditure |
Tax saving from |
£25,000 |
£10,000 |
£10,000 |
£50,000 |
£20,000 |
£11,800 |
£100,000 |
£40,000 |
£15,400 |
Tax Tip
Clearly where full relief is not obtained in the initial period there will be further tax relief in subsequent years but maximising tax relief early has an important impact on tax cash flow. Businesses that routinely spend upwards of £25,000 annually on qualifying plant or those planning a major building refurbishment which includes qualifying replacement plant such as heating or lighting systems may want to consider the possibility of advancing expenditure before the reduction impacts from April 2012.
In addition to the AIA all businesses are eligible for a 100% allowance, often referred to as an enhanced capital allowance, on certain energy efficient plant and low emission cars.
Motor cars
Significant changes were introduced in 2009 to the tax relief rules on cars purchased from 1 April 2009 for companies and 6 April 2009 for individuals. The tax relief position is now determined by the CO2 emissions of the car not by the price of the car. Cars already purchased continue to get a 20% annual allowance with a maximum annual allowance of £3,000 if exclusively used for business.
The tax allowance on new purchases will depend on CO2 emissions. Essentially those with emissions up to 160 will continue to get the 20% allowance and those in excess of
160 will only be eligible for a 10% allowance. There is no £3,000 restriction.
With effect from April 2012 these allowances will be reduced to 18% or 8% depending on the CO2 emissions.
Industrial and agricultural buildings and hotels
These are currently being phased out with 1 tax year still to run. The entitlement in this final year is 50% of the 2009/10 entitlement. For example, if the entitlement was 2% of a qualifying cost in 2009/10 it is 1% in 2010/11.
Special rules apply for accounting periods straddling these dates.
Paying the tax
The self-employed may have to pay tax and NIC 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.
Practical Tip
The payments on account system can make tax payments very volatile if profits fluctuate widely from year to year. You must plan ahead carefully to avoid nasty shocks.
However if you are having difficulties paying tax liabilities due to the current economic conditions then you may be able to spread payments over a period of time to suit individual business circumstances using the HMRC business payments service. Please contact us for further information if this affects you.
Companies
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 discipline without which all kinds of legal and tax related difficulties can occur.
Corporation Tax (CT) Rates
Corporation Tax |
||
|
2 Years to |
Year to |
Small profits rate |
21% |
20% |
Marginal rate |
29.75% |
28.75%* |
Full rate |
28% |
27% |
The small profits rate normally applies where profits do not exceed £300,000. It also applies to the first £300,000 where overall profits are between £300,000 and £1,500,000. The balance of the profits between £300,000 and £1,500,000 are taxed at the marginal rate. The full rate applies to all profits where those profits are greater than £1,500,000. |
||
As reflected above, the coalition government has announced that CT rates are to decrease from 1 April 2011. Further graduated reductions in the full rate are planned so that the full rate will be 24% from 1 April 2014. The effective marginal rate should also reduce by 1% in each relevant year assuming the basis for its calculation is not altered.
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 NIC, 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 NIC. This requires planning. Please talk to us to decide the best options for you.
Tax on profits
The profits of a limited company are calculated in a similar way as for unincorporated businesses and the same rules about 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
In recent years companies have become more popular as they have usually resulted in less tax being paid overall. Tax rate changes year on year mean that this will not always necessarily remain the case.
This issue is complex as the comparison calculations have to take into account current and future government proposals on income tax and NIC rates. Do get in touch if you would like us to review your particular circumstances.
Payment of tax
PAYE and NIC on salaries is payable monthly (or quarterly where the amount due is less than £1,500 per month).
Corporation tax is usually payable nine months and one day after the year end, so the choice of accounting date has no tax consequence.
Income shifting
Over recent years, many families have been attracted by the savings that can be made by combining small salaries and large dividends. The savings could be increased by introducing a non-working family member into the business as a shareholder or co-owner, to use up their personal allowance and lower rates of tax.
Proposed new rules aimed at counteracting this were due to be introduced from 6 April 2009 but have been shelved for the present. Care still needs to be taken as aspects of the existing ‘settlements legislation’ could still be used to challenge certain arrangements. If you have any questions or concerns, please do not hesitate to contact us.
Value added tax (VAT) and your business
VAT is a tax ultimately paid by the final consumer and businesses act as the collectors of the tax. There are heavy fines for failing to operate the system properly.
What does VAT apply to?
VAT is chargeable on the supply of goods and services in the UK when made by a business that is required to register for VAT.
A registered business must charge VAT on its sales which is known as output VAT. There are currently three rates of VAT which can be payable on what are known as taxable supplies. These are the standard rate of 17.5%, the reduced rate of 5% and the zero rate.
The zero rate applies where the supply is deemed to be subject to VAT but the output VAT is charged at 0%, meaning that no VAT is actually payable. The standard rate will increase to 20% for supplies made on or after 4 January 2011 (see below).
However a business also pays VAT on the goods and services it buys. This is known as input tax.
If the output tax exceeds the input tax, then a payment of the difference has to be made to HMRC. This calculation is normally done quarterly. If input tax exceeds output tax a repayment of VAT will be made. This calculation is also done quarterly except that if repayments occur regularly this can be done monthly. Regular repayments would perhaps apply where a business generally makes zero rated supplies.
Supplies
Certain supplies of goods and services are not subject to VAT at all and are known as exempt supplies. A business that makes only exempt supplies cannot register for VAT and will be unable to reclaim any input tax.
Tax Tip
When you first register for VAT you can reclaim input tax on goods purchased up to three years prior to registration provided they are still held when registration takes place. VAT on services supplied in the six months prior to registration may also be reclaimed.
As there are three rates which can be applicable to taxable supplies, standard, reduced or zero rated, it is important to identify the type of supplies correctly and apply the correct percentage of VAT.
Some input VAT is not reclaimable by a VAT registered business. Two common examples are VAT incurred on entertaining business customers and VAT on the purchase of a car.
Do I need to register?
A business must register if its taxable supplies exceed an annual figure, currently £70,000. If taxable supplies are less than this a business may still register voluntarily. So, for example, if the business makes only zero rated sales, it can still register and reclaim the input tax suffered.
Since 1 April 2010 all new businesses that register for VAT and businesses already registered with a turnover exceeding £100,000 have to file their VAT returns online. Additionally, any VAT due will need to be paid online as well. It is a stated HMRC intention that generally all businesses will have to do the same from 1 April 2012.
VAT can affect competition. A plumber, for example, who sells only to the general public, will be at a disadvantage if he has to register for VAT.
He may have to charge up to 17.5% (20% from 4 January 2011) more than a plumber who is not registered to earn the same profit.
On the other hand, if the same plumber only works for other VAT registered businesses, such as building companies, then it will not matter if they are registered because the customer will be able to recover the VAT that is charged.
Indeed, in general, a business that always sells to other VAT registered businesses will normally register, even if below the annual limit, because then it can reclaim VAT on purchases and expenses.
This will improve profit. This can be especially relevant for new businesses because there are often high initial set up costs that carry VAT.
On the other hand registration comes at the cost of having to meet onerous record-keeping requirements, a need to submit VAT returns on time and a fundamental need to get it right!
Failure on any of these points exposes the business to penalties which, in some cases, can be substantial.
Tax Planning
You should consider carefully whether to register voluntarily. If the VAT at stake is relatively small the responsibilities of registering may outweigh the benefit.
Change in VAT rate
The Chancellor announced in the Emergency Budget that the standard rate of VAT was to increase from 17.5% to 20% from 4 January 2011.This will mean that most VAT registered businesses will need to exercise great care when completing the VAT return that spans the changeover date, and some will need to apportion their supplies across the January date.
The time of supply rules will be of great significance, so a clear understanding of those will be vital to getting invoicing right. Where an invoice is issued before 4 January, or payment is received, a tax point will be generated, fixing the applicable rate of VAT.
Tax Planning
This means that there is scope for charging 17.5% instead of 20% by advance invoicing or payment.
Whilst there is legislation in place to prevent certain types of misuse of this process, there are also opportunities for a number of businesses and individuals.
This is demonstrated in the example below so if you would like to discuss the best way to approach invoicing across this period we would be pleased to help you.
Example
A car dealer takes full payment on 30 December 2010 for a new car with a VAT exclusive cost of £20,000 to be delivered to his customer on 1 March 2011. VAT is correctly accounted for at 17.5% amounting to £3,500.
This is a saving to the customer of £500 (2.5% of £20,000) as the time of supply would be treated as the payment date.
Practical Tip
There are various VAT schemes designed to reduce administration and/or improve cash flow for the smaller business so do contact us for further information.
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