When starting a business you will have to deal with income or corporate taxes. The taxation legislation is extensive and can be confusing for an individual starting a business.
A Chartered or Certified Accountant should be consulted when you are dealing with the taxation affairs of the business. The payment of taxation has a direct impact on your cash flow.
This guide does not cover all the tax ramifications of a new business, nor does it detail all the expenses you can claim for, nor does it give details of allowances available on the purchase of some capital items.
Which Accounting Year Should I Choose
If you expect profits to rise steadily year by year, in the case of sole traders/partnerships, an accounting date early in the tax year, for instance 30 April, might be best in the short term, because this will defer the payment of tax on your profit.
However, it is important to consider what will happen when you retire. Any accounting date other than 31 March will cause a bunching of your tax liabilities because all your profit that has not been assessed prior to your retirement will be assessed for your final year.
If you expect to make losses in your early years, an accounting date late in the tax year, for instance, 31 March, will ensure that you get tax relief for those losses as quickly as possible. You would then not be faced with the bunching problem on retirement referred to above.
It will also be necessary to bear in mind the seasonality of your business. As part of the profit for your first period of trading could be taxed twice, it would be unfortunate if a poor choice of accounting date were to accelerate the tax on the profit of your first busy period. In these circumstances it might be preferable to run your first accounts to a date just short of your peak period.
Company Tax Rates
Companies are charged corporation tax at the rate applicable during the financial year (1 April – 31 March). Where a company’s accounts period spans two financial years the profits for the period are apportioned between the years.
The corporation tax rate used to change most financial years, but since 1 April 2017 the rate for almost all companies has been 19%, irrespective of their level of profits.
Budget 2021 announced that the rate would be increased to 25% from 1 April 2023 where profits exceed £250,000 a year. From that date the 19% rate would only apply to profits up to £50,000 a year with a marginal rate of 26.5% for profits for profits between the two new thresholds.
The £50,000 and £250,000 thresholds are pro-rated for short accounting periods and also divided by the number of limited companies under common control. Consequently, from a corporation tax perspective it will not be advantageous to set up lots of companies.
Corporation tax self-assessment requires a company to calculate its own liability to corporation tax and pay that liability by the normal due date, nine months after the end of the accounting period, without an assessment being raised.
Sole Traders/Partnerships
Sole traders and partnerships are charged income tax at the rate applicable during the fiscal years (6 April – 5 April). The rates are as follows:
*A zero-starting rate for savings income up to £5,000 is available but this rate does not apply if taxable non-savings income exceeds that amount. The first £2,000 of dividend income is tax free. In addition, the following amounts of interest income will be tax free:
• £1,000 a year interest tax free for basic rate taxpayers
• £500 a year interest tax free for higher rate taxpayers
Tax free interest will not be available to those with income in excess of £150,000 a year.
Taxation of Dividends
An important factor to consider when deciding whether to trade via a limited company or as an unincorporated business is the total amount of tax payable, not just the rate of tax on the profits. The current 19% rate of corporation tax makes a limited company appear very attractive. However, the shareholder/director then has to pay tax personally on the profits that he extracts from the company, so there is effectively double taxation.
A big cost here is national insurance, payable by both the employer and employee on amounts extracted as a salary or bonus. Many owner-managed companies have tended to extract profits by paying themselves a low salary, with the balance being paid out as a dividend to minimise NICs.
Individuals will pay no income tax on dividend income received up to £2,000. However, dividend receipts in excess of £2,000 will be taxed at:
• 7.5% for basic rate taxpayers (previously effectively 0%)
• 32.5% for higher rate taxpayers (previously effectively 25%)
• 38.1% for additional rate taxpayers (previously 30.56%)
The new dividend rates have resulted in a significant tax increase for owners of small companies, who have for some years been able to extract profits from their business with a tax-efficient mixture of salary and dividends. The chancellor’s justification was to make tax-motivated incorporation less attractive, although arguably still more tax efficient than trading as an unincorporated business.
Tax Credits
There are two elements – Child Tax Credit and Working Tax Credit, although these are gradually being replaced by a new system of Universal Credits.
Child Tax Credit (CTC) is for families who are responsible for at least one child or qualifying young person. You should claim if you have a child or qualifying young person who usually lives with you. You do not have to be working to claim CTC.
Working Tax Credit (WTC) is for people who are employed or self-employed (either on their own or in a business partnership), who:
• get paid for their work
• expect to go on working for at least 4 weeks
And who are either
• aged 16 or over and responsible for at least one child, and usually working at least 16 hours a week, or
• aged 16 or over and disabled, and usually working at least 16 hours a week, or
• aged 25 or over and usually working at least 30 hours a week, or
• aged 50 or over and are starting work after receiving certain benefits for at least 6 months and usually working at least 16 hours a week, or
• aged 60 or over and work at least 16 hours per week
Child Benefit
This basic credit is payable by reference to the number of children of the claimant. From 7 January 2013, an income tax charge has applied to this benefit where a claimant, their spouse, civil partner or person living with them earns over £50,000 per annum.
The charge is 1% of the child benefit received for every £100 of the higher earner’s earnings that exceeds £50,000 in the tax year. So, if either you or your partner’s income is £56,000, you will be taxed on 60% of the child benefit received. This is called the “High Income Child Benefit Charge”.
If your income reaches £60,000 then Child Benefit is recovered in full by the High Income Child Benefit Charge. Alternatively, the claimant can disclaim Child Benefit.