A Guide to Tax and National Insurance for Small Businesses

There are only two certain things in life, and one of them is paying taxes. Read our guide and make sure you're up to date

A Guide to Tax and National Insurance for Small Businesses

If you’re starting a business, it is essential that you at least know the basics of tax and national insurance and your tax obligations.

Tax inspectors will pay just as much attention to the profits and accounts of a small business or sole-trader as they would a large firm.

What are the different taxes businesses should be aware of?

There are a range of different taxes which depend on the type of business, business formation and how your business operates.

Income tax and corporation tax: Income tax applies if you are self-employed or an employee of a business. If you are a limited company then you must pay corporation tax.

National Insurance: National Insurance (NI) is a form of tax paid by both employers and individuals.

Value Added Tax: Value Added Tax (VAT) is tax on the supplies and sales of goods and services. Find out about VAT and how to register your business for VAT here.

Capital Gains Tax: You may have to pay capital gains tax when you sell certain assets for more than you originally paid for them.

Stamp duty land tax (SDLT): A fee charged on transfers of land and property. For commercial property transactions, rates on transfers (excluding shares) are:

Property or lease premium or transfer value SDLT rate
 Up to £150,000 – freehold or leasehold with annual rent under £1,000 0
 Up to £150,000 – leasehold with annual rent of £1,000 or more  1%
 £150,001 to £250,000  1%
£250,001 to £500,000 3%
Over £500,000 4%

However, SDLT no longer applies in Scotland. Instead you pay Land and Buildings Transaction Tax when you buy a property.

Do you qualify as self-employed?

If you’re your own boss and trade as a sole trader or as a partnership then you’re classed as self-employed. You must be in control of what you do, how, and when you do it, have more than one customer, have a right of substitution, and have an element of business risk.

Income tax

For the income tax year 2015/2016 there are three income tax bands:

20% basic rate on income tax between £0-31,785

40% higher rate on income tax between £31,786-£150,000

45% additional rate on income tax over £150,001

For a full breakdown of income tax rates and allowances, click here.

Tax for the self-employed

If you’re self-employed then you pay tax on the profits you make.

Say for instance you make £28,000 profit, you will pay income tax on the full £20,000, even if you have drawn only £8,000 as a salary and retained the other £20,000 in the business.

Usually you will pay tax on the profits for the 12 month accounting period which ends in that year with two equal tax instalments, one on January 31 (during the tax year) and one after the end of the tax year on July 31.

Interim amounts payable are based on the previous year’s tax liability. If profits are down, it is possible to reduce payments.

A balancing payment will then be due on the following January 31 to adjust for the difference between the amounts paid and the tax due as a result of the actual profits.

Corporation tax

Corporation tax is payable on the profit (excluding expenses) plus investment income and chargeable gains of a limited company. Businesses have to calculate their own corporation tax; interest will be charged on underpayments and late returns will incur automatic penalties.

Since 1st April 2015, corporation tax has been 20% for all businesses regardless of the amount of profit they make.

From 2017, it will be reduced to 19% and then further reduced to 18% in 2020.

Small to medium-sized companies with profits of up to £1.5m have to continue to pay corporation tax nine months after the end of the accounting year.

Businesses with profits over £1.5m must pay corporation tax by quarterly instalments.

Business expenses

When working out your business’ profit you need to ensure that you exclude your expenses but you should only include allowable expenses; personal expenses do not qualify. Business expenses which qualify include:

Goods and materials – anything you buy in and then resell.

Director and employee wages, pensions and employer NI contributions.

Premises costs – rents and rates, this will especially apply if you’re a home-based business.

Selling costs – such as marketing and advertising expenses.

Capital allowances

The purchase of premises and equipment cannot be claimed as an expense; instead you have to claim it as capital allowance.

Capital allowances are deducted from your profits, in a similar fashion to allowable expenses, and apply to both limited companies and self-employed business owners.

Capital allowances are usually spread over a number of years with the value reduced each year by the previous year’s tax allowance.

Capital allowances can range from 0% to 100% depending on what your business is and what equipment or premises you are purchasing.

100% capital allowances apply to:

Energy saving and environmentally-friendly equipment.

Businesses purchasing electric cars and low-emission cars (emitting up to 95g/km of carbon dioxide).

The first £250,000 of investment on plant and machinery (excluding cars) via the Annual Investment Allowance scheme which is open to businesses of all sizes.

You can also receive 10% capital allowances on adding essential features to buildings, thermal insulation and long-life assets through the ‘special rate’ pool.

Industrial buildings and hotels which qualify can receive 3% capital allowance. Equipment which is subject to the main rate is classed together in a ’main rate pool’ with capital allowances calculated at 18% of the total value.

Business assets which have a “useful life” of four years or less are deemed ‘short life assets’ and can qualify for increased capital allowances on disposal.

New spending on company cars also qualifies for capital allowances with different rates for the car’s carbon dioxide emissions.

Cars emitting more than 160g/km will be allocated to the ‘special rate’ pool with 10% capital allowances. Cars emitting less than 160g/km are allocated to the main rate pool with 18%.

It is important to note that only improvement to equipment counts as capital expenditure whereas repairs to machinery and equipment are fully tax-deductible.

Capital allowances are deferrable which means that if you make a trading loss and have no tax to pay, you can defer the tax benefit until a later year.

Businesses not registered for VAT can still claim capital allowances on the VAT charged on the equipment purchased.

Tax allowances on company cars and commercial vehicles

If you are self-employed and using your own car for work then you need to keep an estimate of what percentage of your mileage was for business purposes. To this end, it’s important to keep a record of business miles travelled to satisfy the tax inspector.

One way to provide evidence of your business mileage is to make sure your mileage reading is noted whenever your car is serviced.

If your car is used purely for business then you can claim 75% of the capital allowance.

You may also be able to claim an allowance from HMRC’s Approved Mileage Allowance Payments (AMAP).

Mileage allowances

Employees using their own cars for business will usually receive a mileage allowance which, if paid in line with HMRC’s AMAP, bears no extra liability. If the mileage is greater than AMAP then the difference is taxable.

AMAP for cars and vans is 45p a mile up to 10,000 miles, and 25p a mile thereafter. Employees using company cars must privately pay income tax on this ‘benefit’ and the employer also has to pay out NI.

The cost of this is calculated using the list price of the car and its CO2 emissions – electric cars and vans have a 0% list price percentage so no income tax will need to be paid.

Fuel provided for private use is subject to tax and employer’s NI as a benefit and is based on a fuel charge.

Pre-trading expenses

Most of the costs associated with setting up a business are usually allowable as business expenses in the first year, provided that you have officially notified HMRC that you have started a business.

However, there are some costs which are not allowable, such as training courses.

For security make sure you keep a record of all your business expenditure including receipts, invoices and bank statements, and set up a separate bank account to make it easier.

If you start up a limited company the formation costs incurred are not allowable.

Income tax rates and allowances

Individuals will receive a basic personal allowance of £11,000 for the tax year 2016/2017 (will be £11,200 in 2017 to 2018).

This is only available to those earning less than £100,000.

Your personal allowance goes down by £1 for every £2 that your adjusted net income is above £100,000.

This means your allowance is zero if your income is £121,200 or above.

Other forms of non-taxable income and allowances:

Working Tax Credit. You may qualify if you’re in paid work, including self-employment. Find out more about working tax credit here.

Child Tax Credit. You could get Child Tax Credit for each child you’re responsible for if they’re under 16 or under 20 and in approved education or training.

Redundancy payments below £30,000 . These are usually tax-free.

Certain social security benefits. Depending on your circumstances maternity and child benefits, family credit, and disability living allowance may be tax-free.

Money borrowed personally and then lent to the business by directors and partners. Directors can claim interest on the capital.

Trading losses

If you’re a limited company you can offset your trading losses against all other income in the accounting period.

Alternatively, you carry these losses forward against profits from the same trade to reduce future tax bills or you can offset your losses against profits from the previous year.

If you’re self-employed, you can offset trading losses against other incomes received such as earnings from a job, in addition to any capital gains arising in that year.

On the other hand, you can carry these losses forward to offset against future profits from the same trade or carry back your losses up to three years.

National Insurance

If you are self-employed then you must pay Class 2 and Class 4 National Insurance Contributions (NICs) to the Department for Work and Pensions.

Class 2 National Insurance Contributions

You pay Class 2 if your profits are £5,965 or more a year. The NI flat rate for the year 2015/2016 is £2.80 a week.

Class 4 National Insurance Contributions

You pay Class 4 if your profits are £8,060 or more a year. The rate for the year 2015/2016 is 9% on profits between £8,060 and £42,385 and 2% on profits over £42,385.

Find out more about National Insurance Contributions here.

Capital Gains Tax

Capital gains Tax is a tax on any profits or gains you make when you sell or give away an asset such as property, shares, or office equipment. If you sell something for more than you paid for it, then you may have to pay Capital Gains Tax.

How to calculate your Capital Gains Tax

To work out your Capital Gains Tax bill, begin by calculating all of your individual gains and losses for each asset you have sold or ‘got rid of’ for that tax year. Then deduct any losses you’ve made from the tax year from the gains to calculate the overall net gain.

If your overall gain is lower than the annual tax-free allowance, known as the Annual Exempt Amount, then you have no Capital Gains Tax to pay. The Annual Exempt Amount for 2015-2016 is £11,100.

If your overall net gain is higher than the Annual Exempt Amount, you can then deduct unused losses from a previous tax year and deduct enough of these losses to reduce your gains so it meets the Annual Exempt Amount. You can then carry the rest forward to future tax years.

If your overall gain is still more than the Annual Exempt Amount then you are liable for Capital Gains Tax and you will then need to work out which rates of tax to use.

Capital Gains Tax Rates

If your overall net gain is more than £11,100 then your Capital Gains tax is based on a flat rate, either 18% or 28%, depending on the total amount of your taxable income.

If your combined taxable gain and income fall beneath the upper limit of the basic rate of income tax (which currently stands at £31,866), you will have to pay the 18% rate.

If your combined taxable gain and income reaches above the upper limit of the basic rate of income tax, then you are liable to pay 28%.

If you’re an entrepreneur selling your business, you may be able to receive entrepreneurs’ relief which provides a reduced Capital Gains Tax rate of 10%.

You can find out more about Capital Gains Tax and which assets come under the Capital Gains umbrella here.

How can I pay less tax?

Start-ups projecting a first-year loss can delay incorporation and incorporate at a later date.

However if you’re making profits and have a solid cashflow, you may want to reduce your profit at the end of the year thus reducing your tax bill.

To do this, you could bring forward the purchase of items of equipment that you will have to buy later and make full provision for specific bad debts.

If you have made capital gains through the disposal of an asset, you will receive 50% income tax relief and a capital gains tax exemption when those gains are reinvested in a new, small business under the Seed Enterprise Investment Scheme (SEIS).

SEIS looks to incentivise investment in early stage companies and has an investment cap of £100,000 per annum; if the full amount is not utilised, any surplus can be carried back to the previous year.

Other tax allowances

Additional tax allowances also include:

A benefit on low-interest loans given to employees; normally taxable as income for loans over £10,000.

No tax on long-service awards for up to £50 for each year of service for an employee who must have served for a minimum of 20 years.

Annual staff parties or similar celebrations paid for by the employer of less than £150 per head a year.

Employees who receive shares under a tax-favoured share scheme – employees utilising Share Incentive Plans (SIPs) can use up to £1,500 of their salary each year to buy shares free of tax and NI.

Employees adopting the ’employee shareholder’ status who purchase company shares – employees will be exempt from capital gains tax on gains up to £50,000.

The first £2,000 of shares will also be exempt from NICs and income tax.

For more information on tax and National Insurance visit HMRC’s dedicated tax guides, or contact a tax specialist from The Chartered Institute of Taxation or the Association of Taxation Technicians.

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