Introduction »

Running a business

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:

Sole Trader

This is the simplest form of business structure 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.

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.

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.

Plant and machinery - Annual Investment Allowance (AIA)

The AIA gives a 100% write off on most types of plant and machinery costs, but not cars, of up to £100,000 per annum. 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% taxpayer on differing levels of qualifying main pool plant purchases in the tax year of expenditure.

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

The tax allowance on a car purchase depends on CO2 emissions. Essentially those with emissions up to 160g/km attract a 20% allowance and those in excess of 160g/km will only be eligible for a 10% allowance. With effect from April 2012 these annual allowances will be reduced from 20% to 18% and from 10% to 8% depending on the CO2 emissions.

Cars purchased prior to April 2009 continue to generally attract a 20% allowance in 2011/12. This also reduces to 18% from 6 April 2012. Where these older cars are separately pooled, the £3,000 restriction which caps the annual allowance continues to apply.

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.

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.

Corporation Tax Rates

As reflected above, the government plans to further reduce the full rate first to 24% from 1 April 2013 and then to 23% from 1 April 2014. The effective marginal rate should also reduce by 1¼% 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 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.

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 20%, 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.

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.

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 £73,000. 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. Online filing and payment will be extended to all businesses 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 20% 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 whether he is 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 and 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.

Introduction »