This Briefing Provides an Introduction to the Taxes Most Likely to Affect Your Business

Tax and NI

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

1.1Both the self-employed and employees pay income tax (see 2, 3 and 4).

1.2A limited liability company pays corporation tax (see 5).

1.3Employers are responsible for collecting and paying the tax on employee pay and benefits (see 9).

1.4Employers are also responsible for paying National Insurance (NI) contributions for, and on behalf of, employees (see 10).

1.5Value added tax (VAT) is payable on VATable ‘supplies’ (usually sales) of goods and services (see 11).

1.6Capital gains tax (CGT) may be payable when certain assets are sold for more than they cost (see 12).

1.7Stamp duty land tax (SDLT) is charged on transfers of land and property.

SDLT rates on commercial property transactions are 1% on transactions between £150,000 and £250,000, 3%between £25,001 and £500,000 and 5% over £500,000. Stamp duty at 0.5% is charged on share transfers above £1,000.

1.8Substantial 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).

2.1You 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.

2.2If you trade as a limited company, you will be an employee of the company.

This also applies to shareholding directors.

2.3If the company contracts your services to a single client, who would otherwise employ you, it will probably be classed as a personal service company where special rules apply.

3. Tax for the self-employed

3.1The 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 includingyour salary (see 6 and 7).

3.2You 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.

3.3New 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.

3.4Tax 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

4.1There are currently threeincome tax bands (for the tax year 2013/14 ):

Taxable income (£)Tax rate
0- 32,01020%
32,011 – 150,00040%

Over £150,00045%

These tax bands apply to both employees and the self-employed.

4.2The taxable income is reduced by a personal allowance.

For the tax year 2013/14 , the basic personal allowance is £9,440(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 £9,440.
The basic personal allowance is onlyavailable 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.

5.1There are threecorporation tax bands for the year ending 31 March 2014:
Profit (£)Tax rate
1-300,00020%

300,000–1,500,00023.75%
Over 1,500,00023%
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.

A reduced 10% rate of corporation tax — known as the Patent Box — is available for profits which can be attributed to patents and other intellectual property. The scheme is optional and businesses must ‘opt in’ to benefit.

The main rate of corporation tax will be reduced to 21% in 2014 and will be aligned in 2015 with the small profit rate at 20%.

5.2
The main rate of corporation tax will be reduced to 21% in 2014 and will be aligned in 2015with the small profits rates at 20%.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.

6. Expenses

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:

6.1Goods 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.

6.2Any 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 225%. This means you can set £225off 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.

6.3Costs 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 chargesand fixed costs such as mortgage interest as business expenses.

6.4Selling costs, including marketing and advertising expenses.

6.5Finance costs, such as bank charges and interest (including leasing and hire purchase interest charges).

6.6General running expenses, including telephone, travel and subsistence (eg hotel costs on a business trip), insurance postage, accounting and other services.

6.7Directors’ and employees’ wages and benefits (see 9), and employer’s NI contributions (see 10).

6.8Bad debts, where specific invoices are unlikely to be paid.

6.9If you are not registered for VAT, you treatthe 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.

7.1In most cases, capital allowances permityou 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.

7.2Capital 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 95g/km of carbon dioxide) and electric cars.
TheAnnual Investment Allowance allows businesses to claim 100% capital allowances on the first £250,000 of investment on plant and machinery (excluding cars). Expenditure over this amount 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 cars with CO2 emissions over 130g/km, integral features of buildings, thermal insulation and long-life assets.
Businesses in designated disadvantaged areas can claim 100% capital allowances for the costs of renovating or converting business premises that have been vacant for more than one year under the Business Premises Renovation Allowance. .

7.3To 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 (2013/14).

Each time you buy something, the cost is added to the value of the pool.

7.4Where 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.

7.5You 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.

7.6If you are not registered for VAT, you can also claim capital allowances on the VAT charged on the equipment you buy.

8. Offsetting losses

8.1If 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.

8.2Limited 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

9.1The 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.

9.2Employee 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 £10,000.
Workplace childcare and up to £55 per week of childcare vouchers for approved childcare and welfare counselling.
Provision of some equipment, office services and consumables. For example, provision of a mobile phone or computer.
Some less commonly-used benefits such as free or subsidised meals, free medical treatment whilst working abroad, health screening and check-ups.

9.3If 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

10.1The self-employed pay much less NI than company employees. But they get substantially fewer benefits.

10.2Employees pay Class 1 contributions. This is deducted from pay at source, along with the employee’s income tax.

Employees earning less than £149a week are exempt.
Contracted-in employees pay 12% on weekly earnings of between £149and £797, plus an additional 2% on weekly earnings over £797. Contracted-out employees in salary-related schemes pay 10.6%.

10.3Employers pay the ‘employer’s contribution’ on pay and benefits.
This is charged at 13.8% for contracted-in employees on earnings over £148a week. There are lower rates for contracted-out employees.

Employers pay nothing for employees earning less than £148a week.
All new employers outside London and the south-east set up between 22 June 2010 and 5 September 2013 do not have to pay £5,000 in NICs for the first ten members of staff hired in the first year of business subject to meeting conditions.

From April 2014, all employers will benefit from a £2,000 Employment Allowance which can be offset against their NIC payments.The allowance will be claimed as part of the normal payroll process through HMRC’s new ‘Real Time Information’.

10.4The self-employed currently pay:

Class 2 contributions of £2.70 a week. The National Insurance Contributions Office collects this. Someone earning less than £5,725a year can apply to be exempted. Ask for form CF10.
Class 4 contributions of 9% on profits of between £7,755and £41,450plus an additional 2% on annual profits over £41,450.

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 under certain circumstances.

11. VAT

Unless a specific relief applies, VAT is payable on all sales (of goods and/or services), and is recoverable on most related purchases.

11.1The reliefs are laid down in legislation whichare:

‘exempt supplies’covering 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.

11.2All businesses must pay VAT, but only those that are VAT-registered and make VATable supplies can reclaim it. VAT is unlikely to be reclaimable if some or all of the activities are VAT exempt.

Businesses – whether companies, sole tradersor partnerships – must register once their annual turnover exceeds the VAT-registration threshold of £79,000.
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 £77,000).
Businesses trading below the VAT-registration threshold may choose to register after weighing the advantages (the ability to recover VAT) against the disadvantages (having to charge VAT and the costs of administration).

11.3Certain small and medium-sized businesses have the option of using the cash accounting scheme.

VAT paid to HMRC is based on sales revenue actually received, while the amount reclaimed is based on the purchase invoices that have been paid. This avoids the problems that can otherwise arise with late payment of credit sales 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.

11.4Small 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.

11.5A 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.
A business must leave the scheme if turnover exceeds £230,000.
The net VAT payable to HMRC is calculated as a percentage of turnover (as specified by HMRC) rather than being the net difference between VAT charged and VAT paid on individual transactions.The scheme reduces compliance but not necessarily the amount of VAT paid.

12. Capital gains tax