How does small business tax work?

Tax is one of those thing that many entrepreneurs don’t want to think about. This is especially the case in the early days of a new business when your focus is understandably elsewhere. That said, small businesses must take tax seriously or they can fall foul of the regulations. In recent years, the UK’s tax authorities, known as HMRC, have tried to make it easier for small businesses to sort out their taxation but it still means you have to keep good financial records, at the very least.

Whether it is income tax, tax credits, VAT or National Insurance many owners of start-ups get confused by taxation. Thankfully, this handy guide contains all the main things that business owners need to get started with their tax returns. So, to make a go of your business, what are the important taxes that new businesses need to take account of?

The taxes small business pay

Although there are special rules for certain types of business – such as those in the agriculture sector or those which derive money from overseas investments – the common taxes you need to pay as a small business in the UK are:

• Income tax.
• Corporation tax (if you run a limited company).
• Local business rates (if you occupy commercial premises).
• National Insurance Contributions (NICs).
• VAT (if your yearly turnover exceeds £85,000 as of 2018).

Let’s deal with each in turn.

Income tax

If you are a sole trader, then income tax must be paid each year based on your total income. Your income is deemed to be the same as that of the business, not on any notional salary you pay yourself from the business’ bank account. Of course, you can claim tax relief against any deductible expenses you have paid out for in the course of the accounting period in question. For example, you can deduct any capital allowance you are entitled to for new equipment you need for your work. Sole traders can also deduct the cost of things like clothing which are used for work and a little rent for a home office they might use.

This means your taxable amount is derived from your profit, not your turnover. However, you can only claim for legitimate business expenses, not things that you have used personally. It is best to keep receipts for any expenses you have claimed tax relief against so that, if questioned, you can prove that this expenditure was allowable under the rules. If you are unsure whether you can claim for something or not, then seek professional advice from an accountant.

Unlike employees, who use the PAYE system with tax deductions on each payslip, sole traders calculate their taxable income once a year. This is the same for all self-employed people, regardless of whether their enterprise’s profit is used to calculate the sum that needs to be paid. No matter which taxation entity the authorities deem you to be in, you still receive the same tax-free personal allowance. A self-assessment tax return must be submitted to HMRC after the end of every tax year.

Corporation tax

This form of taxation only needs to be paid by small business people in self-employment who have registered their enterprise as a limited company. All limited companies must settle this form of business tax but it means that you can pay yourself in a more efficient manner, perhaps with dividends rather than a salary. You will still need to complete a self-assessment tax return, but the income of your business will be treated as separate from your personal taxable income if you choose this type of legal entity for your business.

Business rates

Business owners who occupy a non-residential address will be charged rates by their local authority. It is a bit like the equivalent of council taxation but for businesses. The charge relates to the rateable value of the property which is a formula derived from its rentable value. Since many small business owners operate from their home address, this is a small business tax that does not need to be paid by everyone. The tax rates that apply can vary a great deal depending on where in the country you operate.

National insurance contributions

Most self-employed people pay Class 2 and Class 4 NICs. One is a flat rate that is charged for every week of the given tax year. The other is worked out according to your level of profit in the previous financial year. If you are a sole trader, the fee for both classes on NICs are calculated when you complete your annual tax return. If you are a director of a limited liability company or a partner in a limited partnership, then you can calculate your NICs liability in a different way which can reduce the amount you are obliged to pay, depending on your exact circumstances. It is worth noting that the rates for NICs can vary in Scotland which has its own tax-levying powers under devolved arrangements.

Value added taxation

VAT is a business tax that only applies if your turnover is relatively high. Business owners are liable for it regardless of whether they have made a profit or a loss in the previous financial year. As such, it is an expense you need to allow for even if your tax return will show a loss. It must be applied to certain goods in the UK at the rate of 20 per cent. You must calculate all of the VAT you have charged for in a tax year and declare this to HMRC. Bear in mind, however, that you can deduct any VAT you have paid out to suppliers before you settle your bill.