Tax and your Business

The most important word to bear in mind when you start out in business is ‘preparation’. Spending some time creating a business plan can be invaluable. It will bring to mind many issues which you may not have considered, such as financing, numbers of employees and the business structure, which will help you meet your aims. Do you want to run the business by yourself or in partnership with someone else, or would you rather trade under the umbrella of a limited company?

Sole trader

This is the simplest form of business since it can be established without legal formality. However, the business of a sole trader is not distinguished from the proprietor’s personal affairs.

Partnership

A partnership is similar in nature to a sole trader but because more people are involved it is advisable to draw up a written agreement and for all partners to be aware of the terms of the partnership. Again the business and personal affairs of the partners are not legally separate.

Company

The business affairs are separate from the personal affairs of the owners but there are legal regulations to comply with.

Limited Liability Partnerships (LLPs)

LLPs are a halfway house between partnerships and companies. They are taxed in the same way as a partnership but are legally a corporate body. This means that the personal affairs of the members can be separated from the business affairs.

The appropriate structure will depend on a number of factors including consideration of taxation implications, the legal entity, ownership and liability.

Important choices

Some matters are broadly the same no matter which route you take.

Year end
Choosing the right year-end may, in some circumstances, defer a tax bill but there will also be other commercial issues to consider.

Expenses
Tax will be due on the profits of your business but not all expenses the business incurs are tax deductible. Careful thought needs to be given as to when and how much money is going to be spent.

In general, it is best to incur expenditure just before rather than just after the year-end, as this will accelerate your tax relief. However, it is important that you keep proper and comprehensive business records so that relief may be claimed. Examples of the type of expenditure to consider bringing forward include:

building repairs and redecorating
advertising and marketing campaigns
redundancy and closure costs
expenditure on plant and machinery.

Capital allowances
Generally an annual allowance of 25% is given for expenditure on plant and machinery. Small and medium-sized businesses (as defined by company law) qualify for higher allowances in the year of expenditure (generally 40%). 100% allowances are available to all businesses for expenditure on certain specific energy saving equipment and, until 31 March 2008, on certain environmentally friendly cars.

Allowances are also available for investments in certain types of building.

Unincorporated businesses

Whether a sole trader, partnership or LLP, your profits will be taxed on a ‘current year’ basis, so that the business is taxed on the profits it makes during its lifetime; for example, if the business makes up accounts to 30 April each year, the profits for the year ended 30 April 2005 will be taxed in 2005/06.

By choosing the most appropriate accounting date, the payment of tax can be delayed, with significant cash flow advantages.

Unincorporated businesses usually pay higher rates of tax than a company but significantly less national insurance. Administrative costs are generally lower but you are personally liable for debts the business may incur. LLPs go someway to addressing this issue.

Limited companies

A limited company may be advantageous, as the directors are not personally liable for outstanding debts. However, a creditor, such as a bank, may require personal guarantees from the director.

Tax rates paid by the company will generally be lower than those paid by an unincorporated business. However, there are effectively two layers of tax, one payable by the company and the other payable by employees/directors. Thus, profits made by the company need to be extracted by the directors in the most tax efficient manner.

You may wish to consider extracting profits in the form of dividends rather than as increased salary or bonus. This can result in substantial savings in national insurance. However, dividends paid out by certain companies may affect the company’s corporation tax. Planning should be undertaken before any money is taken out of the company.

Tax Tip

There are various ways of extracting profits from a company although careful consideration of the level and method needs to be given. For example payments by the company to an approved pension scheme are tax and NI free!

And finally...paying the tax

The self-employed may have to pay tax three times a year, namely:

31 January in the tax year
31 July following the tax year
31 January following the tax year.

In certain circumstances, the first two payments can be waived.

For limited companies, the payment system can be more complicated:

PAYE and NI needs to be paid monthly even if the director is the only employee (although for smaller businesses it can be paid quarterly)
for most companies corporation tax is payable nine months and one day after the end of the accounting period.

As you can see, there are many issues to consider in deciding the best vehicle for your business. Please contact us to discuss the situation in detail.