WHAT BUSINESS TAX TO CONSIDER FOR START-UPS
Starting your own business can be exciting but daunting at the same time. Between figuring out your costs, overheads and potential profit margins you could make, there’s little room to think of tax issues.
Here is a simple guide to help you be prepared for tax season.
Corporation Tax or CT is the main tax you will need to be worried about. Income tax on individuals is a progressive tax, meaning if you earn more, you pay more tax percentage-wise.
Corporation tax is a flat rate; therefore, it encourages businesses to try to expand their operations and earn more income.
Sole traders are taxed slightly differently: while you do have to file a return as a corporation would do and work out your tax bill, the actual calculation is more similar to that of an individual, meaning that you could have a personal allowance.
You also need to pay NI Class 4 depending on your profits.
Even better, income tax on individuals is on the gross amount earned, without factoring in daily expenses.
For companies, CT is applied to the bottom line, meaning there is tax relief from all the expenses incurred in the year.
This reduces a company’s tax bill but also encourages commerce as the company will hire people and make business purchases.
The rates for CT are set by HMRC every year and it has been 19% in previous years, dropping to 18% for the year 2020. Here is a table of historic CT rates:
*In the years before 2014 UK distinguished between a small profits rate, for companies with profits under 300,000 and the main profits rate. This gave a slight advantage (1%) to smaller companies and helped to lower their tax bill. In more recent years, there is no more separation between the two terms, and instead, we have the main rate for all profits (except ring fence profits).
As you can see, tax rates for companies in the UK have continued to go down for the last 10 years.
It’s speculated that this is a part of a larger plan to continue to lower tax rates well into the future to attract business. In Ireland, the CT rate is just 12.5% and, while this is no tax-free haven, it still has attracted names such as Google and Facebook.
Moving forward, if the UK were to compete with Ireland, they would need to continue lowering tax rates to a similar level.
CORPORATION TAX ON CAPITAL GAINS
While individuals pay income tax and capital gains tax, for companies, any capital gain is taxed in the same way as trading income.
This can be a good thing, as capital gains tax for individuals is a progressive tax and company tax is a flat rate across all earnings. Therefore if you have a significant capital gain, it’s usually more advantageous from a tax perspective to record this within an incorporated company rather than a person.
Reliefs are avenues to reduce your tax legally set out by HMRC. Essentially, they allow further tax relief, even after all qualifying expenses have been considered.
The main relief claimed by companies is Capital allowance. You can well see this as a form of depreciation – the difference is that depreciation is used in the books of account to give you the accounting profit and capital allowances are solely used to calculate taxable profit.
While depreciation rates can vary depending on the assets purchased and management’s judgement, capital rates are specific percentages set out by HMRC.
R&D reliefs are quite generous if you manage to meet the definition of a qualifying R&D expenditure. The main reason is that R&D can be too costly for companies to undertake and sometimes may not have the expected results. Therefore, the state is incentivising companies to invest in research and technology for the betterment of society.
This is why they are paid even if the project does not achieve its intended outcome.
R&D reliefs for SMEs are:
-230% of the qualifying expense: i.e. the full cost of the R&D 100% plus 130% additional to reduce your profit if you are profit-making
-tax credit of 14.5% of the suspendable loss for companies which are not profitable yet to use against future profits
R&D reliefs for large corporations are slightly less generous.
If you work in a creative industry such as Film, Theatre, Museums but also Television and Video Games, there are multiple state aids available, as well.
VAT (Value Added Tax) is an indirect tax on the consumer. Meaning that, if the company is the end consumer, they will pay the VAT on the products and services bought. But if they go on to resell any purchases, the VAT will then be transferred over to the final customer.
Therefore, VAT is not necessarily a tax on corporations per se, but corporations are liable for correctly accounting for VAT and collected the VAT amounts on time on behalf of HMRC.
A business does not have to be VAT registered until revenue of £85,000 is reached. This means that if you are not VAT registered you do not charge VAT on your products and services.
A company can still self register for VAT if the revenue is below £85,000 threshold.
Learn more detailed article about VAT in the UK
TAKING MONEY OUT OF THE BUSINESS
Your company is up and running, and all taxes are taken care of. But what happens when you are a Director, and you want to pull cash out of business?
Essentially, if you are taking money out of the business either through a salary or through profit distributions (dividends), you would still be liable to income tax and capital gains tax as an individual.
While there is no way around this, performing a tax computation in advance will prepare you for the most efficient combination of salary and dividends, depending on your other personal tax affairs.
For most people who do not hold significant assets or other incomes, it is most efficient to be paid a low salary which is within the 20% bracket and which offers them the full personal allowance. The remaining can be paid as dividends, which are taxed under CGT.
This is standard practice and accepted by HMRC, and you may change how you choose to pay yourself as a Director if your other tax affairs dictate and within reason.
Any products or services used from the business for your benefit will need to be treated as a benefit to the Director and, therefore taxed under Income tax.
Therefore, if you have a bookstore and give a book to a friend, rather than considering the book under direct cost heading for the CT, this will be a benefit to the Director and taxed as part of your income tax computation.
If you want to read more about personal tax visit this page.
Government: Corporation Tax Rates & Reliefs
List of information about corporation tax.