Our Small Biz, Small Bitez are a collection of posts on specific topics designed to deliver easy to read info which may not be so easy, but are essential that every entrepreneur knows when it comes to starting a business.
In Accounting 101 we demystify all that accountancy jargon so you can take control of your small business finances.
Steven Marsh of Marsdens Chartered Accountants works closely with us at London Small Business Centre providing pro-bono work to our entrepreneurs. We asked Steven to flag up the absolute key essentials you need to know when it comes to the numbers game but without you having to plough through all the plethora of information that’s out there.
A couple of weeks back we looked at the difference between a Sole Trader and Ltd Company and how to do your own Bookkeeping. Now we’re exploring Common taxes for small businesses
What are the common taxes for small businesses?
As the owner of a small or medium business, you will encounter various types of tax that will need to be paid to HM Revenue & Customs. These can vary depending upon whether you are an unincorporated business, such as a Sole Trader or Partnership, or an incorporated business such as a Limited Company.
It is useful to have an understanding of these taxes both in terms of whether they apply to you and how much they might cost you.
Income tax applies to individuals so if you are a Sole Trader, a Partner in a Partnership or an Individual and you make sufficient income or profits you will have to pay this. Income Tax does not apply to Limited Companies.
The amount of income tax you will pay depends upon the level of your annual income or profits. In the UK, the tax year runs from 6 April in one year to 5 April in the next. So the current tax year runs from 6 April 2015 to 5 April 2016, known as the 2015/16 tax year.
For the 2015/16 tax year, the first £10,600 of your income or profits will not be taxed at all. This is known as your Personal Allowance, the amount you can earn before you pay any tax.
If you earn between £10,601 and £42,385, this slice of your income will be taxed at 20%. From £42,386 to £150,000 it is 40% and for the lucky few earning over £150,000 per annum, that top slice will be taxed at 45%.
There are further detailed rules beyond the scope of this article that can mean certain individuals can receive more than £10,600 per annum tax free and how earnings over £100,000 carry an extra burden of income tax.
National Insurance (NIC)
Although this is technically not a tax, effectively it is a tax in a similar way to Income Tax.
There are several types of National Insurance. If you are employed then you may have to pay Class 1 NIC. For the 2015/16 tax year approximately the first £8,000 of your income is ignored, then between this figure and just over £42,000 per annum the rate you will pay is 12% of your salary. If you earn more than just over £42,000 salary per annum, then the excess has 2% NIC levied on it.
If you are Self Employed, such as a Sole Trader or a Partner in a Partnership you may have to pay Class 2 NIC and Class 4 NIC. Normally, you pay a flat rate of Class 2 NIC regardless of what you earn and for the 2015/16 tax year, this is £2.80 per week. However you can apply for exemptions if your Self Employed income is likely to be very low.
Sole Traders and Partners in a Partnership may also have to pay Class 4 NIC. Unlike Class 2 NIC, Class 4 is not at a flat rate but on a sliding scale dependent upon the level of your annual profits. For 2015/16 the approximately first £8,000 of your profits are ignored then between this amount and just over £42,000 of profits it is levied at 9% then any excess above just over £42,000 is levied at 2%.
Corporation tax is the tax that Limited Companies have to pay on their profits. If you trade as a Limited Company, at the end of your Company’s financial year, you or your accountant will prepare your Company’s annual Accounts and Company Tax computation and Return and any profit will be taxed at a rate of 20%. This is your Limited Company’s tax liability and not your personal liability. It is payable nine months and one day after your Company’s financial year end. Unlike individuals, your Company’s financial year end is unlikely to be 5 April. It is set, by default, at the end of the calendar month the year after you form your Company. So if you form your company on say 7 July 2015, unless you elect to change it, your Company’s year end will be 31 July 2016. Where you have traded for one year to say 31 July 2016, your Company will pay its corporation tax on or before 1 May 2017 which is nine months and one day after its year end.
Value Added Tax (VAT)
VAT is a tax charged on certain goods and services. It can be an extremely complex tax as there are many rules and differing scenarios to which it may or may not apply.
Any business, whether a Sole trader, Partnership or Limited Company has to register for VAT if its “taxable supplies” which means its Sales, exceed a certain figure and for the 2015/16 tax year, that figure is £82,000. By registering, the business will receive a VAT number and have to charge VAT on most goods and services it sells. There are exceptions however, and not all goods and services are subject to VAT and some are charged at a lower rate than the standard rate of VAT which is currently 20%.
Once a business is registered for VAT it can normally reclaim any VAT that it has been charged on purchases and expenses that it has laid out for its business (subject to certain rules) and in principle the business will account to HM Revenue & Customs, normally every three months for the difference between the VAT it has charged on its Sales, less the VAT it has incurred on its Purchases and Expenses.
There are alternative VAT schemes for small businesses which can be financially advantageous.
A business may register for VAT before its taxable supplies reach the figure of £82,000 (for 2015/16) and this is known as a Voluntary Registration. There can be a financial advantage in doing this.
Some businesses that make wholly or mainly Exempt sales, should not have to register for VAT. If you think this may apply to you, you should seek expert advice in good time.
Capital Gains Tax (CGT)
This is less common than the previous taxes referred to and arises if you make what is known as a “capital gain”. A capital gain arises if you sell an investment, land, property or certain other items known as capital items, at a profit. CGT is a complex tax but the principle is that it taxes capital gains above a certain limit. Every individual is allowed to make a certain amount of gains CGT free each tax year and for 2015/16 the CGT free threshold is £11,100. If your gain is more than this, you would normally pay CGT on the excess. There are differing rates of CGT depending upon your total level of other income and gains in the tax year. The basic rate of CGT for 2015/16 is 18% and the higher rate 28%, but in some circumstances, special exemptions or reliefs may exist which mean that you may pay CGT at lower rates, or not at all for the time being. It is also important to be aware that sometimes you do not physically have to sell an item to be subject to CGT. You can gift an item for example and not receive any sales proceeds, but still be liable to CGT.
Companies do not technically pay CGT. They pay Corporation Tax (see above) on their capital gains at a rate of 20% and Companies are not entitled to the £11,100 annual exemption referred to above.
Tax is a complex subject and the subject discussed in this article are a basic introduction to the most common taxes. They all have their own intricate rules, exceptions and particular impact and interpretation so you should always seek appropriate professional advice before trying to interpret anything that has been referred to above.
Steven is known amongst his many clients and family and friends, as being the accountant who “eats, sleeps and breathes tax and enjoys explaining to clients little known and easy to implement tax gems of advice that are not always publicised or much known about”. Aside from helping entrepreneurs with their businesses, he’s a serious collector of old comics, cigarette cards, autographs, original artwork, but mainly of rare British Queen Victoria and Queen Elizabeth postage stamps and related items.business advice
Remember: Always seek specific advice for your business and your circumstances before you proceed in order to avoid any costly mistakes!