The tax system for businesses
For most companies - their total tax bill is one of their largest business expenses. Taxation of companies includes a lot more than corporation tax.
This is especially true from the perspective of owner managed businesses, where it's important to consider the different ways profits are extracted from the business and the personal tax liabilities this involves.
This guide summarises the main types of tax that a small company is liable for, and the additional personal taxes paid by owner managers. As well as ensuring you understand your obligations, it provides the overview and background for our guides to tax planning.
Tax on business profits
Corporation Tax is paid by companies on their taxable income after deducting allowable expenses and taking into account various allowances and reliefs. Although normally referred to as a "tax on profits" the amount subject to tax will differ from your accounting profit. The current rate of tax is 20%, and current Government policy is to reduce this to 17% by 2020. Companies are responsible for calculating their own tax liabilities - by completing a corporation tax return (CT600). This has to be accompanied by accounts and computations, which form part of the return. Normally these must be filed online, and tagged electronically (iXBRL). Payment of Corporation Tax is normally due 9 months and one day after the company’s “normal due date” – usually the last day of your annual accounting period. The exception to this is for larger companies, who may be required to pay in quarterly installments.
Sole Traders and Partnerships
If you haven't incorporated your business and instead operate as a Sole Trader, Partnership or LLP then there is no Corporation Tax payable. Instead the taxable income of the business is treated as personal income of the owners (for Partnerships and LLP's this is based on the profit share agreements you have in place). Taxable income is calculated on very similar principles as used for Corporation Tax above, the key differences being that:
- Any amounts you pay yourself as business owner(s) aren't treated as salary, and aren't an allowable business expense.
- The taxable income, after allowable expenses and other reliefs, is taxed as income tax so subject to a rate of 0%, 20%, 40% or 45% depending on your overall levels of income.
Tax is reported and paid as part of your self assessment tax return(s), which must be reported and paid by 31 January (if filed electronically). Partnerships file a partnership return in addition to the individual self assessment tax returns. In most circumstances payments will need to be made on account, due on 31 January and 31 July, with the balance paid the following 31 January.
Value Added Tax is the tax you have to pay when you consume many goods and services. It is levied on most business transactions - with businesses having to charge VAT on goods or services they are supplying, while being able to offset VAT they've paid on goods and services they've consumed.
Not all goods and services are subject to VAT, and some have a lower rate, but for most business transactions the standard rate of 20% applies.
Companies must register for VAT if they supply taxable goods and services which have a total value in a 12 month period that's above the VAT registration threshold. This is currently £85,000 (from 1st April 2017). Businesses must also register for VAT if the predicted value of their taxable supplies in the next 30 days alone is expected to exceed the annual VAT threshold. It is important to remember that this is measured on turnover, not profit.
All VAT-registered businesses must submit their VAT returns online, normally quarterly, and settle any outstanding tax liabilities electronically.
There are a number of different VAT schemes available to small businesses - such as the flat rate scheme, and cash accounting scheme, and these should be considered as part of your overall tax planning.
Income Tax and PAYE
Although not an expense of your business, your business still has an important obligation to report and collect income tax paid by your employees. This is known as the PAYE system. This obligation can extend to how you use subcontractors in your business:
- When you engage someone to do work for you you have to decide whether the terms of the work mean you need to treat them as an employee subject to PAYE.
- If you're involved in construction, then the Construction Industry Scheme rules may create further obligations to deduct and report tax on subcontractors (see our guide for further details).
Income tax also plays a role in your overall tax planning strategy. For owner managers it's a key consideration in how you extract profits from your business. For employees, giving them opportunities to reduce their income tax using pension contributions and certain benefits, can be an important part of staff retention and engagement.
Real Time Reporting (RTI) obligations
You need to report detailed information about your employees earnings, Income Tax and National Insurance deductions each time an employee is paid. This must be done no later than the payment is made. Even if you don't pay anyone in a month, you are still responsible for reporting this with a "nil return" no later than the 5th of the following month. There are further year end reporting obligations, where you need to issue a summary of all PAYE for the tax year (form P60) and any taxable benefits given to employees (P11D).
You need to make payments by no later than 22nd of the following month (assuming you pay electronically). If your average monthly payments are less than £1,500 in total then your business can pay quarterly by 19th July, October, January and April. Payments for any P11D benefits are due by the 19 July following the end of the tax year.
How to operate PAYE
Meeting your PAYE obligations is usually done electronically using specialist software. While this helps manage the complexity of the process, the level of fines and penalties involved if mistakes are made mean that for most SME's it's more effective to use a payroll bureau or your accountancy practice to take care of this for you.
National Insurance Contributions
Employers have two roles when it comes to National Insurance.
Collecting employees contributions
Your business is responsible for collecting the "Class 1" National Insurance Contributions that their employees have to pay out of their salary. These aren't an expense for the business but can form part of an overall tax optimisation strategy. By structuring how you compensate your employees (e.g. by making some types of benefits available, as an alternative to salary) you can help them keep more of what they earn, improving staff engagement and retention.
Your business is also responsible for paying additional National Insurance Contributions. These are an expense for your business and can considerably increase your overall costs.
- "Secondary Class 1" contibutions must be paid on all earnings above the "secondary threshold" at a rate of 13.8%. The "secondary threshold" is usually £162 per week, or £702 per month, depending on how frequently you perform your payroll. Different thresholds apply for employees under 21 and for apprentices under 25.
- "Class 1A" contributions must also be paid on most benefits you provide your employees. These payments are annual and based on the cash equivalent value of the benefit.
Any salary paid to Directors is subject to Class 1 National Insurance Contributions, just like any other employee of your company. For owner managers this makes Directors salary an expensive way of taking money out of the business compared to other methods that don't incur National Insurance (such as dividend payments). National Insurance Contributions are a key component of your overall tax planning for extracting profits from your company.
If you're self employed then any "salary" you pay yourself doesn't count as employment income (for PAYE or National Insurance). Instead you pay Class 2 and Class 4 contributions. Class 2 contributions are a fixed amount (£2.95 per week for 2018/19) assuming your profits are above the small profits threshold (currently £6,205). Class 4 contributions are paid on any taxable business income above the "lower profits limit" (currently £8,424). You pay 9% above this limit, reducing to 2% on profits above £46,350.