Being your own boss has many advantages, but it also brings a lot of responsibility and a great deal to think about. Getting your tax right as a small business is incredibly important, but it can also be extremely confusing.
Types of tax
Class 2 National Insurance
HMRC now collect Class 2 National Insurance via their self-assessment system. This is an annual payment of £145.60 that protects your entitlement to State Benefits. It also counts as your annual ‘stamp’ for state pension eligibility. You don’t have to pay Class 2 National Insurance if your annual self-employment profits are below £5,975.
If your business is registered for VAT you can charge VAT on products and services, when hiring or lending someone goods, when selling business assets, commissions, and items such as canteen meals sold to staff members. Any items you can charge VAT on are called ‘taxable supplies’, and different rules apply for imports, exports, and charities.
You can’t charge VAT if you’re not registered but if you are registered you MUST charge it. If you’re registered you can reclaim any VAT you have paid on products or services that are business-related. You are responsible for reporting the amount of VAT you’ve charged and paid to HMRC on your VAT return, which is due quarterly.
If you are a limited company, a foreign company with an office or branch in the UK, or a club, co-operative, or unincorporated association such as a sports club, then you will also have to pay corporation tax on your business profits. You will not be billed for corporation tax, instead you will need to calculate, report and pay it.
Income tax record keeping
It’s vital you keep excellent records of all business expenses and sales. When your income tax is calculated it is done so based on how much money comes into your business, how much goes out, and how much of what goes out is tax deductible. You will pay income tax on the amount of non-deductible profits you make. This means you need perfect records of how you earned your income, and receipts for everything you have purchased which you are claiming against your tax bill.
Legally you’re not required to have a separate business account, however from a tax perspective everything is a lot simpler if you do. Having a dedicated bank account saves you a massive amount of time, as you know all transactions running through that account are business-related, and therefore must be accounted for in your tax returns. It’s worth taking the time to shop around for an account, as some banks offer accounts specially designed for sole traders. Once you have your account, don’t forget to budget for bank fees!
One vital element of tax for small businesses is understanding what is and isn’t deductible. As a general rule, any expenses that are wholly, exclusively, and necessarily incurred for business purposes are tax deductible. You must ensure you retain any receipts in case you are audited. Receipt scanning is an excellent way of doing this, as apps allow you to quickly and easily scan receipts into a system that saves them for you.
Certain expense categories are a little more complicated in terms of what is and isn’t deductible:
Entertainment – generally speaking, paying to entertain clients (including buying food and drinks for them and yourself) is not deductible.
Petrol expenses – these may be deductible if you use the capital allowances method, but the majority of the time using the business mileage allowance method is preferable.
Wages – any money paid to yourself is not deductible.
Charity donations – any money you collect from clients and donate to charity is not deductible.
Fines – even if they are incurred while visiting clients or working, speeding, parking, and other fines are not deductible expenses!