The taxes every small business needs to understand

Even successful small businesses can have problems if they misunderstand the rules around the tax that they need to pay. The system of taxation in the UK is very complicated and it is not surprising that so many businesses get something wrong – but doing so can lead to a large tax bill down the line and potentially even a fine for making the mistake.

It is important then, to do your research beforehand and get real insight into the taxes you need to pay. Some small businesses function as sole traders and others as limited companies; we will always try to provide insight into both positions. This will help you to understand your tax obligations regardless of the way your business is set up. So here are the most important types of taxation that every small business needs to know about and understand.

National insurance

We’ll start with one that isn’t technically a tax – although it is money that has to be paid to the government, so it is effectively a tax, it just isn’t officially described as such. If you are operating as a sole trader then you will pay two different sorts of National Insurance (NI) and the process can seem a little complex.

First, you pay a weekly flat rate of NI, currently at £3.05 (Tax Year 2021 / 2022) called Class 2 NI (unless your business’ profits are under £6,515, which is known as the Small Profits Threshold). If your profit is under the Small Profits Threshold then you can still opt to pay Class 2 NI on a voluntary basis, as this will protect your entitlement to a state pension as well as providing other benefits. You will need to contact HMRC to arrange to make the voluntary contributions. 

Once your business profits (measured as income less allowable business costs) go over £9,569 (2021 / 2022) you’ll also start to pay Class 4 National Insurance which is worked out as a percentage of your profits. For the tax year 2021 / 2022 Class 4 NI is calculated at a rate of 9% on profits between £9,569 and £50,270 then 2% on profits over that higher threshold.

It is different if your business is a limited company and you pay yourself a salary. If the company pays you more than (2021 / 2022) £184 per week you are required to deduct Class 1 employee’s NI from your wages. The company will also incur Class 1 Employer’s NI on your salary. Both the employees and employers National Insurance are paid to HMRC along with any income tax deducted from your salary.

Dividend Tax

Of course, you may have decided to pay yourself a small salary with the rest of the amount that you want to take out of the business being paid as a dividend. Dividends do incur Dividend Tax at the following rates:

    • First £2,000 of dividends – tax free
    • 7.5 % for dividends falling within basic rate tax 
    • 32.5% for dividends falling within higher rate tax
    • 38.1% for dividends falling within the additional rate of tax 

Income tax

Income tax is another problem area for business owners. It is relatively simple if you are a sole trader and you don’t have another job; you will pay income tax on your business’ profit as soon as it exceeds your personal allowance of £12,570 (2021 / 2022).

If your business is a limited company you would need to pay income tax on any salary or dividends that are given to you by the company – of course, this depends entirely on what you pay yourself. As an individual paying income tax on your salary (in this case to your own company) the business deducts it from your salary under the PAYE scheme.

VAT

You might think of VAT as something that only individuals pay, but it is a relevant tax for businesses too. Whether your company is a sole trader, a partnership, an LLP, or a limited company, making sales of more than £85,000 per year requires you to register the company for VAT. VAT is usually charged at a standard rate of 20 percent, but there are some exceptions.

Corporation tax

This is an example where sole traders and limited companies have completely different rules governing them. A limited company must pay corporation tax on profits. Unlike in the case of individuals, there is no personal allowance for limited companies. This means that as soon as your business makes a profit, you are required to pay corporation tax.

Corporation tax is charged at 19 percent for all companies (although this rate is rumoured to be increasing in future years) and is payable nine months and one day after the company’s accounting year ends. Corporation Tax, and the associated returns, do tend to be more complex than the self-assessment tax returns for a sole trader. Along with the mix of dividends and salary, this is often an area where businesses choose to work with accountants to ensure compliance with the rules is achieved.

Business rates

This is another aspect of business tax that can depend entirely on your circumstances. For example, if you run your business from a commercial space or an office then you may be required to pay business rates such as council tax. However, if you are a sole trader who works from home you will not usually need to pay these sorts of business rates unless you have a dedicated business space and routinely bring clients to your home. If you do more than work from home it is worth contacting your local council to see if business rates would apply to you.

This article was updated in October 2021 by Elaine Clark, Chartered Accountant Managing Director of CheapAccounting.co.uk and TaxBootCamp.co.uk

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