This briefing provides an introduction to the taxes most likely to affect your business. The sooner you set up systems for maintaining your records, and the better you keep them, the less money you will need to spend on professional help in dealing with the tax authorities. It will also be easier to plan for your liabilities.
Nevertheless, it is well worth consulting a tax expert — a qualified accountant, solicitor or tax adviser. An expert may be able to save you much more in tax than you spend on fees. But as well as sparing you time and effort, it should also help you avoid running into problems.
This briefing covers:
- Which taxes will affect your business.
- What can be classed as genuine business expenses.
- Your responsibility for calculating and paying tax and National Insurance (NI) for your employees.
- Tax breaks for investors in small and medium-sized companies.
1. Different taxes
1.1 Both the self-employed and employees pay income tax (see 2, 3 and 4).
1.2 A limited liability company pays corporation tax (see 5).
1.3 Employers are responsible for collecting and paying the tax on employee pay and benefits (see 9).
1.4 Employers are also responsible for paying National Insurance (NI) contributions for, and on behalf of, employees (see 10).
1.5 Value added tax (VAT) is payable on VATable ‘supplies’ (usually sales) of goods and services (see 11).
1.6 Capital gains tax (CGT) may be payable when certain assets are sold for more than they cost (see 12).
1.7 Stamp duty land tax (SDLT) is charged on transfers of land and property.
- For commercial property transactions, SDLT rates on commercial property transactions are 1% on transfers in excess of £150,000, 3% in excess of £250,000 and 4% in excess of £500,000. Stamp duty at 0.5% is charged on share transfers above £1,000.
1.8 Substantial tax breaks are available to investors in small or medium-sized businesses (see 13).
2. Are you self-employed?
People who are self-employed can benefit from significant short-term tax and NI advantages compared with employees (see 3 and 10).
2.1 You are self-employed if you are your own boss and trade as a sole trader or member of a partnership. To convince HM Revenue & Customs (HMRC), you must at least show that you:
- control what you do, and how and when you do it
- have more than one customer
- bear an element of business risk
- have a right of substitution.
2.2 If you trade as a limited company, you will be an employee of the company.
- This also applies to shareholding directors.
2.3 If the company contracts your services to a single client, who would otherwise employ you, it will probably be classed as a personal service company.
3. Tax for the self-employed
3.1 The self-employed pay income tax on their profits — not on their drawings. For example, if you make £30,000 profit, you pay income tax on the full £30,000 — even if you draw only £10,000 as salary.
- Profit is business turnover less allowable expenses, and not including your salary (see 6 and 7).
3.2 You pay tax on the profits made over the accounting period (usually 12 months) which ends in that tax year.
- Tax is due in two equal instalments, on 31 January (during the tax year), and on 31 July (after the end of the tax year).
- The interim amounts payable are based on the previous year’s tax liability. Arrangements can be made to cut payments, if profits are falling.
- If the profits made are higher than those for the previous year, a balancing payment is due on the following 31 January.
3.3 New businesses may be taxed twice on their first-year profits, depending on the accounting period you choose.
- ‘Overlap relief’ will be available to compensate you for this, but the calculations are complex and there will always be a cashflow cost to the business. Consult your accountant or tax adviser.
3.4 Tax planning can ensure the self-employed pay tax due later than employees.
- For example, if your accounting period ends on 30 June 2011, you pay tax on the profits for the period on 31 January 2012 and 31 July 2012 (both payments being based on the previous year’s tax liability).The final payment (based on actual profits) will not be made until 31 January 2013.
4. Income tax
4.1 There are currently three income tax bands (for the tax year 2012/13):
Taxable income (£) Tax rate
34,371 – 150,000 40%
Over £150,000 50%
These tax bands apply to both employees and the self-employed.
4.2 The taxable income is reduced by a personal allowance.
- For the tax year 2012/13, the basic personal allowance is £8,105 (more for those over retirement age).
- If you run your own business, and your spouse has no other income, it makes sense for tax purposes to employ him or her on a salary of at least £8.105.
- The basic personal allowance is only available to people earning less than £100,000. Where income is more than £100,000, the amount of the allowance is reduced by £1 for every £2 above the limit.
5. Corporation tax
Corporation tax is payable on the profits — business turnover less allowable expenses, plus investment income and chargeable gains — of limited companies.
5.1 There are three corporation tax bands for the tax year 2012/13:
Profit (£) Tax rate
Over 1,500,000 24%
If your profits fall between £300,000 and £1.5 million, you are eligible for marginal relief. This is designed to ease the transition from one rate to the next. The limits are reduced for companies belonging to groups.
5.2 Companies have to calculate their own corporation tax liability.
- If profits are likely to be in excess of £1.5 million, companies pay corporation tax by quarterly instalments. All other companies continue to pay corporation tax nine months after the end of the company’s accounting period.
- Interest is charged on underpayments (and paid on overpayments).
- The tax return has to be filed within 12 months after the end of the accounting period and must be accompanied by accounts. Late returns incur automatic penalties.
You need to be clear about what expenses are allowable when working out your profit figure.
Business costs are allowable, but personal ones are not. Allowable expenses include:
6.1 Goods and materials, including anything your business buys in and then resells.
- Be careful about the value you put on your stock at the year end. A common mistake is to value it at selling price, rather than cost. This inflates your profit figure and increases your tax bill.
6.2 Any spending on research and development (R&D) by small and medium-sized limited companies.
- You can claim R&D tax credits on qualifying spending at 200%. This means you can set £200 off against your profits, for every £100 you spend.
- R&D tax credits apply to the costs of staff and consumable stores used in your R&D efforts, including expenditure on software, power, fuel and water.
- Companies not yet in profit (or not yet trading) can claim cash payments instead.
- You must spend £10,000 or more on R&D a year to claim these credits.
6.3 Costs associated with your premises, such as rent, rates and heating.
- If you work from home, you can usually count a fair proportion of your domestic bills such as electricity and telephone charges and fixed costs such as mortgage repayments as business expenses.
6.4 Selling costs, including marketing and advertising expenses.
6.5 Finance costs, such as bank charges and interest (including leasing and hire purchase interest charges).
6.6 General running expenses, including telephone, travel and subsistence (eg hotel costs on a business trip), insurance postage, accounting and other services.
6.7 Directors’ and employees’ wages and benefits (see 9), and employer’s NI contributions (see 10).
6.8 Bad debts, where specific invoices are unlikely to be paid.
6.9 If you are not registered for VAT, you treat the VAT element as part of your expenses.
- If you are registered, VAT is reclaimed separately (see 11).In addition to allowable expenses, you can claim allowances to reflect investments you have made in plant and machinery (see 7).
7. Capital allowances
Whether you are self-employed or trading as a limited company, you cannot count the full cost of purchasing or improving premises and equipment as an expense. Instead you have to claim a ‘capital allowance’, which is then set off against your profits like an allowable expense.
7.1 In most cases, capital allowances permit you to write off a percentage of the value of the asset against profits, over several years.
- You apply the percentage to the original cost in year one, and write the value of the asset down by that amount.In subsequent years, you apply the percentage to the written-down value, so that the allowance gradually declines.
7.2 Capital allowances range from 0% to 100%, depending on who you are and what you are purchasing.
- There are 100% allowances for energy saving and environmentally beneficial equipment. Loss making businesses can surrender losses attributable to expenditure on such equipment in exchange for tax credit.
- There are also 100% capital allowances for businesses purchasing low-emission cars (emitting up to 110g/km of carbon dioxide).
- The Annual Investment Allowance allows businesses to claim 100% capital allowances on the first £25,000 of investment on plant and machinery (excluding cars). Expenditure over this amound will be dealt with under the main or special rate pools (see below). The Annual Investment Allowance is open to all businesses, not just small and medium-sized ones.
- The ‘special rate’ pool gives 8% capital allowances on integral features of buildings, thermal insulation and long-life assets.
- The allowance for qualifying industrial buildings and large hotels is 3% a year, based on cost.
- Since 11 April 2007, businesses have been able to claim the Business Premises Renovation Allowance. It gives businesses in designated disadvantaged areas 100% capital allowances for the costs of renovating or converting business premises that have been vacant for more than one year.
7.3 To make life simple, all equipment (except cars) subject to the main rate is generally put into a ‘pool’, and capital allowances are calculated at 18% of the total value (2012/13).
- Each time you buy something, the cost is added to the value of the pool.
7.4 Where assets have an expected life in the business of four years or less, you can elect for them to be treated separately as short-life assets. This can accelerate tax relief.
7.5 You can choose to defer claiming any capital allowances.
- The whole process of writing down the assets is simply delayed by a year, leaving their value unchanged.
7.6 If you are not registered for VAT, you can also claim capital allowances on the VAT charged on the equipment you buy.
8. Offsetting losses
8.1 If you are self-employed, you can offset trading losses against other income received in that tax year or the preceding year, such as earnings from a job or income from investments, plus any capital gains arising in that year.
- Alternatively, losses can be carried forward to offset against future profits from the same trade. Losses in the first four years, or in the last year, may also be carried back up to three years.
8.2 Limited companies can also offset their trading losses against other income in the accounting period.
- Losses incurred in the initial accounting period of a new company can be carried forward to reduce future tax bills, or carried back for one year to reclaim tax already paid.
- Losses can also be carried back for three years when a business is closed down.
9. Tax and employees
9.1 The employer must deduct employees’ income tax from each wage payment. The tax must then be sent to HMRC on a monthly or quarterly basis.
- Employers can make quarterly payments of PAYE (Pay As You Earn) and NI if their average net monthly payments fall below £1,500.
- Most redundancy payments under £30,000 are tax free.Any overpayment or underpayment of tax will be corrected once employees have sent their tax returns in.
9.2 Employee benefits are generally taxable. There are some exceptions:
- Payments into HMRC-approved pension schemes.
- Approved schemes to encourage employees to take up shareholdings.
- Low-interest loans of up to £5,000 from the employer.
- Workplace childcare and up to £55 per week of childcare vouchers for approved childcare and welfare counselling provided by employers.
- Provision of some equipment, office services and consumables. For example, provision of a mobile phone or the loan of a computer.
- Some less commonly-used benefits.
9.3 If you trade as a limited company, you could cut the tax bill for your employees by introducing tax-favoured share schemes. Such schemes can provide employees with incentives for staying with the company and promoting its success.
- Enterprise Management Incentive schemes allow small firms to give key employees tax-favoured share options.
- Share Incentive Plans (SIPs) allow companies to give their employees up to £3,000-worth of shares each year, free of tax and NI.
Some or all of this can be awarded in respect of performance targets.
Employees can buy shares free of tax and NI, out of their pre-tax salaries, up to a maximum of £1,500 a year.
Employers can give their employees up to two free shares for each share purchased.
Provided the shares are held for at least five years, no tax or NI will be payable.
10. National Insurance
10.1 The self-employed pay much less NI than company employees. But they get substantially fewer benefits.
10.2 Employees pay Class 1 contributions. This is deducted from pay at source, along with the employee’s income tax.
- Employees earning less than £146 a week are exempt.
- Contracted-in employees pay 12% on weekly earnings of between £146 and £817, plus an additional 2% on weekly earnings over £817.
- Contracted-out employees pay 13.8%.
10.3 Employers pay the ‘employer’s contribution’ on pay and benefits.
This is charged at 13.8% for contracted-in employees on earnings over £156 a week. There are lower rates for contracted-out employees.
- Employers pay nothing for employees earning less than £156 a week.
- Start-up employers outside London and the south-east have not had to pay £5,000 in NICs for the first ten members of staff hired in the first year of business. All new businesses set up since 22 June 2010 will benefit.
10.4 The self-employed currently pay:
- Class 2 contributions of £2.65 a week. The National Insurance Contributions Office collects this. Someone earning less than £5,395 a year can apply to be exempted from Class 2 contributions. Ask for form CF10.
- Class 4 contributions of 9% on profits of between £7,605 and £42,475 plus an additional 2% on annual profits over £42,475.
HMRC collects this at the same time as income tax.
If you have a job as well as working on a self-employed basis, you pay Class 1 contributions. In this situation, you can apply to defer payment of Class 2 and Class 4 contributions.
Unless a specific relief applies, VAT is payable on all sales (of goods and services), and is recoverable on most purchases.
The reliefs are laid down in legislation. They are ‘exempt supplies’ which include health, finance, insurance, education and many property transactions; ‘zero-rated’ (VATable at 0%) on food, children’s clothes, new houses and printed matter; ‘reduced rate’ payable at 5% on items including domestic fuel, insulating products, safety seats and certain conversions/refurbishments.
11.1 All businesses must pay VAT, but only those that are VAT-registered can reclaim it.
- Businesses – whether companies, sole traders or partnerships – must register once their annual turnover exceeds the VAT-registration threshold of £77,000.
- VAT-registered businesses must charge VAT on their sales of VATable goods and services, and account for the tax to HMRC.
- They may deregister if their annual turnover falls below a certain limit (currently £75,000).
- Businesses with a turnover below the VAT-registration threshold may choose whether to register. They have to weigh the advantages (the ability to recover VAT) against the disadvantages (having to charge VAT, and the costs of administration).
11.2 Certain small and medium-sized businesses have the option of using the cash accounting scheme.
- Amount paid in VAT is based on sales revenue actually received, while the amount recovered is calculated according to the invoices that have been paid. This avoids the problems that can otherwise arise with late payment or bad debts.
- The scheme is open to businesses with a turnover of up to £1.35 million that meet the conditions in HMRC’s Notice 731. The leaving threshold is £1.6 million.
- Eligible businesses do not need to apply to use this scheme but must start from the beginning of a VAT period.
11.3 Small to medium-sized businesses can choose annual accounting, rather than submitting quarterly returns.
- The same threshold limits apply as for the cash accounting scheme.
- Any business under the threshold can use the scheme from the date of VAT registration.
11.4 A flat-rate scheme is available for small businesses.
- It is available to any VAT-registered entity with an annual VATable turnover of up to £150,000.
- The net VAT payable to HMRC is calculated as a percentage of turnover (which is specified by HMRC) rather than being the net difference between the VAT charged and incurred on individual transactions.
This reduces the costs of compliance considerably, but is not primarily designed to reduce the amount of VAT paid.
12. Capital gains tax
Capital gains tax (CGT) is a tax on successful investments, such as those in property or shares. If you sell something for more than you paid for it, you may have to pay CGT.
12.1 Higher-rate income tax payers are liable to pay CGT at 28%. For those paying the lower income tax rate, CGT is charged at a flat rate of 18%.
- Capital gains are added to any other income.
- The first £11,200 of capital gain each year is tax free. A husband and wife or people in a civil partnership can each claim this allowance.
- CGT is payable on 31 January following the end of the tax year in which the gain is made.
12.2 Limited companies pay corporation tax on any capital gain.
- Capital gains are treated as part of the company’s taxable profit.
12.3 The self-employed, like other individuals, pay CGT at a flat rate of either 18 or 28%, depending on income tax paid.
12.4 CGT exemptions include increases in the value of your car and your principal private residence.
- If you work from home and have not claimed any part of your mortgage payments as a business expense, there is usually no CGT on the profits made from the sale of your house.
- Under certain conditions, some investment vehicles, life assurance policies and charitable gifts may also be exempt.
12.5 Capital losses can be set off against capital gains from the same year.
Any excess loss can be carried forward to be set off against future gains.
12.6 Individuals can claim entrepreneurs’ relief on the first £10 million of gains made on the sale of a business or its assets.
- The relief reduces the rate of CGT on gains up to £5 million.
- Claims can be made on more than one occasion up to the £5 million lifetime limit.
- Gains over £5 million are charged at the usual CGT rate.
12.7 Payment of CGT can be deferred.
- You can get ‘rollover relief’ if you sell a building from which you trade (or certain other types of asset), and use the money to replace it with another.
- You can get ‘reinvestment relief’ if you reinvest the gain in qualifying shares in certain types of companies, under the Enterprise Investment Scheme (see 13).
- However, capital gains tax deferral relief has been withdrawn for gains re-invested in venture capital trust shares on or after 6 April 2004.
13. Investments and tax
Various schemes exist to encourage investment in small to medium-sized companies.
13.1 The corporate venturing scheme is designed to encourage big companies to take stakes in smaller, unquoted ones.
- At least 20% of the small company’s shares must be held by individuals.
- Corporate assets must not exceed £15 million before the share issue (or £16 million after it).
- The small company must not obtain most of its income from royalty or licensing agreements, unless they relate to intellectual property or other intangible assets largely created by the company.
- Investors get corporation tax relief (at 20%) if they hold shares for three years. They can defer tax on gains made in corporate venturing, if the proceeds are invested in another qualifying company. They must not hold stakes of more than 30%.
- Capital losses can be set against income.
13.2 Both enterprise investment and venture capital schemes are aimed at boosting investment in small, unquoted businesses.
- The annual limit on investments qualifying for tax relief under the Enterprise Investment Scheme increased to £500,000 for shares acquired from 6 April 2008.
- For investors in venture capital trusts income tax relief on qualifying investments is 30% for the tax year 2011/12.
- Other measures include protection of enterprise investment scheme status if companies go into receivership.
14. Paying less tax
There are widely-used ways of paying less tax.
14.1 New businesses expecting to make a first-year loss can delay incorporation.
- This may be advantageous because the self-employed can offset the tax loss against previous years’ employment income and receive a tax rebate (see 8).
14.2 If you are making profits and your cashflow is sound, it may be worth trying to reduce profit at the year end in order to cut your tax bill.
- Bring forward the purchase of assets that you will have to buy later anyway.
14.3 Payments into a pension scheme are an efficient way of saving tax.
- But such payments will then be locked in.
Weigh up the possibility that the cash will be needed in the business.
15. The 2011/12 tax year
The information in sections 1–14 above applies to the current tax year. The rates and thresholds for the previous year (2011/12) are outlined below.
15.1 Income tax (see 4). The three income tax bands and rates for the tax year to 5 April 2012 were:
Taxable income (£) Tax rate
Over 150,000 50%
15.2 Corporation tax bands (see 5) were:
Profit (£) Tax rate
Over 1,500,000 26%
If your profits fell between £300,000 and £1.5 million, you were eligible for marginal relief. This is designed to ease the transition from one rate to the next. The limits are reduced for companies belonging to groups.
15.3 Allowances (see 4).
- The personal allowance was £7,475.
15.4 National Insurance (see 10).
- Employees earning less than £139 a week were exempt. Other employees paid 12% (10.4% if contracted-out) on any extra, up to £817 a week with an additional 2% above that amount.
- The employer’s contribution was 12.8% on earnings above £139 a week (less if contracted out).
- The self-employed paid £2.50 a week in Class 2 contributions.
- Class 4 contributions were charged at 8% on profits between £7,605 and £42,475 plus an additional 2% on profits over £42.475.
- The earnings limit for exemption from Class 2 contributions was £5,395.
15.5 Capital gains tax (see 12).
- The annual individual exemption was £10,100.
15.6 VAT (see 11).
- A new business had to register for VAT if it made VATable supplies of more than £73,000 in any 12-month period.
Handle with care
Some expenses do not count and cannot be deducted when calculating your profit figure, even though they may seem necessary. They include:
- personal expenses, including living expenses, ordinary clothes, and travel to and from your regular place of work.
- entertaining, including any food or drink bought for clients.
- certain professional fees, such as the costs associated with forming a company and obtaining a lease.
- depreciation. Instead of deducting an element for depreciation, you claim capital allowances (see 7).
- fines, including parking tickets.
Cars and tax
- A. If you are self-employed, and use your own car for work, you must keep a record of business miles travelled.
- Whenever your car is serviced, make sure the mileage reading is noted. This allows you to work out the car’s total mileage for the year — and provides evidence to satisfy the tax inspector.
- You must estimate what percentage of the mileage was for business purposes.
For example, if the business mileage was 75% of the total, you can claim 75% of your car costs (petrol, insurance, repairs) as business expenses.
You can also claim 75% of the capital allowance you would have had if the car had only been used for business (see 7.2).
- Alternatively, you may be able to claim an allowance in line with HMRC Approved Mileage Allowance Payments (AMAP) (see B).
- B. Employees who use their own cars usually receive a mileage allowance.
- If mileage allowances are paid in line with AMAP, there is no extra liability.
If they are greater than AMAP, the difference is taxable.
- AMAP for all cars and vans are 45p a mile for the first 10,000 miles, and 25p
a mile thereafter.
C An employee using a company car or van for private use pays income tax on the benefit, based on a percentage of the list price determined by its carbon dioxide emissions. The employer must also pay NI on the benefit, as if it were part of the employee’s salary.
- If fuel is provided for the employee’s private use, the taxable benefit is based on the car’s carbon dioxide emissions.
- The list price percentage for electric cars and vans is 0%, meaning that no income tax will need to be paid on the benefit.
“Under corporation tax self-assessment, you can be charged a penalty if a return is late, incomplete or incorrect. Do not give HMRC this opportunity.”
Solomon Hare chartered accountants
“If you are self-employed, and profits are falling, you can arrange to reduce tax payments. But be careful not to reduce payments too much — you could end up with a nasty interest charge.”
Bentley Jennison chartered accountants
“Time your purchases so that you buy any equipment you need before your year end. If you make a purchase a day before your year end, you still get the full capital allowance for the whole of that accounting period.”
Henstock Shooter chartered accountants
“Make sure your accounts include all expenditure which has been incurred, even if it has still to be invoiced. It could save you tax.”
Solomon Hare chartered accountants
“Because VAT is a tax on transactions its potential for impact and opportunity runs right through every business.”
“There are a number of opportunities to minimise capital gains tax through effective tax planning and utilisation of the reliefs available.