Taxation for Small Businesses

Dom Smith, Lovewell Blake

When trying to unpick what kinds of taxes you will need to pay attention to, ‘Small business’ is a bit of a catch-all term which, unfortunately, does not mean anything when it comes to taxes. Therefore, it needs to be broken down.

Dom Smith, Lovewell Blake

The first thing to establish is whether you are trading (or want to trade) through an incorporated entity (such as a Limited company) or an unincorporated entity (such as a sole trader or a partnership). You should seek advice on which set-up is best for you, but you should first make yourself aware of what taxes are likely to apply to you:

Taxation for Sole traders and Partnerships

Taxes for a sole trader are relatively straightforward to explain – broadly speaking, you simply pay income tax and national insurance on how much profit your business makes in a given tax year.

It’s important to understand that there is no legal distinction between ‘you’ and ‘your business’ as a sole trader. For example, you may well have a separate business bank account, and you may leave a proportion of your profits in that bank account in order to help the business expand or to manage its day-to-day cash flow. However, no matter what you do in regard to this, it has no effect on your taxes. Your income tax and national insurance will still be calculated on the business profits, it is not calculated on your drawings from the business. The ‘business’ itself does not pay tax, because the ‘business’ and ‘you’ are one and the same for tax purposes.

You may not have any income tax or national insurance to pay if you fall under the personal allowance and/or national insurance thresholds.

The same logic applies to partnerships, the only difference being that the profits will be split between the partners.

Taxation for Limited Companies

A Limited Company is its own distinct legal entity. The limited company will need to pay corporation tax on its taxable profits, and there is no minimum profit threshold or allowance for this.

The more important questions centre around the tax you may personally pay when you wish to withdraw money from the Limited Company.

Since the Limited Company is its own entity, you cannot just ‘take’ money from it the same way you might just take money from a business bank account as a sole trader.

Instead, the money must make its way to you in the same form as it might do for any company that you might work for or have shares in – via salaries and dividends.

As the owner or partial owner of a limited company, you will likely be both a director of the company (Entitling you to a salary) and a shareholder (entitling you to dividends). You will potentially have personal tax and national insurance to pay on the salary and dividends that you withdraw from the company, so it is important that your mix of income is managed in the right way.

In order to pay yourself a salary, you need to have a PAYE payroll scheme in place with HMRC.

Taxation – Sole traders vs Limited Companies

On the face of it, acting as a sole trader appears a lot simpler from a taxation point of view, and to a certain extent, it is. There is no separation between you and your business, the flow of money between any business and personal bank accounts is irrelevant – you just pay your taxes based on how much profit the business makes.

However, this simplicity comes with rigidity. Whilst a Limited company has little flexibility in paying its corporation tax, you do have flexibility from a personal point of view, given that you can decide how and when you wish to take money from the company.

If it seems as though you are paying tax twice through a limited company (Via Corporation Tax first, then personal taxes after) it’s because you are. This is why it is important to manage it correctly.

Other taxes

The other main tax to consider is VAT. If you reach the VAT turnover threshold within any rolling 12-month period, then you must legally register for VAT and start charging the appropriate rate of VAT on your sales. VAT returns typically need to be submitted on a quarterly basis, and must be done so digitally, via software, to meet Making Tax Digital (MTD) legislation.

These rules are not specific to sole traders or limited companies – they apply across the board. There may also be good reason for you to voluntarily register for VAT, before you are legally required to.

In Summary

Tax planning can seem complicated – in this short article alone we have mentioned Income Tax, National Insurance, Corporation Tax, PAYE, and VAT. There is potentially a lot of time, hassle, and money at stake if they are dealt with improperly, and professional advice should always be sought if you are unsure.

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