Tax considerations for a small business

Sole traders, or self-employed people, pay income tax on their profits at their marginal rate of tax.

The marginal rates of tax are 20%, 40% or 45% depending on whether your level of income makes you a basic, higher or additional rate taxpayer. You pay 20% tax on your income up to £50,270, and the rate increases after this.

It’s important to accurately calculate your profits for the year to make sure you pay the correct amount of tax. There are specific rules about which expenses you can and can’t claim.

Sole traders must submit a tax return by 31 January following the tax year, and pay any tax due by this date. If your tax liability is over £1,000, you need to make “payments on account”, which are payments towards next year’s tax liability. You pay these every 6 months – by 31 January and 31 July – and they’re credited on your tax return.

Some sole trade income, for example from subcontractors working in the construction industry, will have already had tax deducted at source, and a credit is given for this on the tax return.

Private limited companies need to file accounts within 9 months and pay the tax due within 9 months and 1 day of their year end. For example, a company with a 31 December year end needs to pay the tax by 1 October.

Companies pay tax on their profits after deductible expenses as well, but it’s important to get this right, as there are differences in the expenses that sole traders and companies can claim.

From 1 April 2023, companies with profits under £50,000 will continue to pay tax at the current rate of 19%. However, companies over £250k will now be subject to tax at 25%. If a company’s profits fall between the two, a marginal rate is used. The marginal rate equates to profits between £50-250k being taxed at 26.5%.

Undeclared drawings from the company are not tax deductible, and neither are dividends. A director’s salary however is tax deductible, but is subject to National Insurance. It’s vital to have a good remuneration strategy to ensure drawdown is happening in the most effective way.

Dividends and salary declared are taxable on the tax return of the director/shareholder.

Businesses with vatable income over £85k will need to charge VAT on their invoices to customers.

They can then reclaim VAT on expenses incurred, and will pay or reclaim the difference with HMRC, usually quarterly.

Businesses paying employees over the employer’s National Insurance (NI) threshold will need to pay NI over to HMRC, usually quarterly. If the employee is paid over the employee’s NI threshold, the business will need to deduct NI and PAYE from their salary and pay this to HMRC along with the employer’s NICs.

There are employment allowances for small businesses which we can advise on.

If a director draws income from a company that is not declared as dividend or salary, it is treated as a loan. If this loan remains unpaid by the Corporation Tax deadline, the company is subject to dividend tax at the higher dividend tax rate of 33.75% on the balance. This is known as section 455 tax.

Once the loan is “repaid” – either by an introduction of funds or by the director declaring a dividend, the section 455 tax is repayable to the company.

Transferring shares as part of succession planning can trigger Capital Gains Tax consequences – with the tax-free limit reducing significantly from April 2023, this could incur a big bill.

Incorporating and disincorporating a business (moving from or into a limited company) also has tax consequences.

However, tax can be mitigated or reduced with careful planning, which is why it’s so important to get good, early advice.

If you feel like any of the issues in this article may affect you, or if you need general advice for your tax return, please feel free to contact our expert Tax Team or click here…