At some point every business will – unless it continually makes a loss – have to address the issue of taxation. Like it or not the government wants its pound of flesh, but there is nothing to stop you structuring your business to get the best tax advantage possible.

This is a complex and often contentious issue but here are some points for you to consider before deciding how best to structure your business. You would however be advised to discuss this subject with your accountant or with James Green & Co whose contact details are shown below.

Taxation of an Unincorporated Business

  • Tax is based on profit regardless of what is taken out.
  • Taxable profit is not necessarily accounts profit: entertaining, private purchases, depreciation & capital allowances are not deductable.
  • As a sole trader or partner the profit will be taxed at normal income tax rates. Currently these are 20% on the first £36,000 and 40% on anything above that. However you get an allowance of £5,435 on which you pay no tax. You will also need to pay Class 2 and Class 4 National Insurance Contributions (NIC) – see below for rates.
  • Tax due for year to 5th April based on accounts for a period ending in the year to 5th April. Care needs to be taken to ensure that tax liability is kept to a minimum. It is perhaps an anomaly that under the “self-assessment” regime the services of an accountant are even more vital!
  • Under “self assessment” there are time limits and severe (and automatic) penalties for error or late provision of information.
  • Husband & wife partnerships allow for some income balancing.
  • Tax is payable in two equal instalments on 31st January in the following tax year and again on the 1st July. Once you have made a return you may also have to pay “on account” for the following year. This is to even out the governments income by making you pay in advance an amount based on the previous tax return.

Taxation of an Incorporated Business

  • Directors are employees so fees and salary are subject to PAYE and NIC as are most benefits in kind – car, fuel, telephone etc.
  • A company pays tax on profits in the accounting period which are adjusted for entertaining etc. (just as for unincorporated businesses) and tax is payable nine months after the accounting date. Therefore if your accounting reference date is 31st March you must pay the tax by 31st December following. Your tax return, however, doesn’t have to be received until 31st March of the next year.
  • Currently the rate for the first £300,000 profit is 21% rising to 28%. The company also has to pay Employers NIC – see below for rates.
  • Dividends are paid out of taxed profits. Share holders receive net dividend taxed at 10%. There is no more to pay if they are a Basic Rate taxpayer but Higher Rate taxpayers are liable to pay 32.5% on any dividend income taking them above the basic limit (£36,000).
  • Payments to shareholders which are not salaries or dividends are deemed to be “distributions”. Thus if £1,000 is taken out £220 of tax has to be paid by the company even if it has not made a taxable profit.
  • Care has to be taken over directors’ current/loan accounts: If these are overdrawn this is classed as a distribution (see above). If they are overdrawn and repaid in year interest may be payable to the Inland Revenue. An overdrawn director’s account could be held in some circumstances to be a breach of company law.
  • Careful administration of your accounts (by your accountant) can allow for regular payments of “interim dividends” on which tax liability can be lower and which does not attract NIC.

National Insurance – Unincorporated Business

Class 2 – £2.40 per week for each person (unless profits under £4,825 per person) – payable by monthly direct debit or quarterly bill.

Class 4 – 8% of annual profits (calculated as for Income Tax) between £5,435 and £40.400 per person and then 1% on any amount over £40,400. The money is payable at the same time as Income Tax is due.

National Insurance – Incorporated Business (and all employees)

Class 1 (Employees Contribution) – If not “contracted out” from the state pension scheme an employee (including a company director) pays 11% on earnings between £105.01 and £770 per week then 1% on anything above £770. If “contracted out” they pay only 9.4% instead of 11% but then 1% above the £770 per week.

Class 1 (Employers Contribution) – If the employee is not “contracted out” their employer pays 12.8% (without maximum) on all amounts over £105 per week. If the employee is “contracted out” into a salary related scheme the employer pays 9.1% on amounts between £105 and £770 per week and 12.8% on amounts above £770 per week. If contracted out to a money purchase scheme the employer pays 11.4% instead of 9.1% and then the 12.8% rate kicks in.

Class 1A – This is payable by employers at 12.8% on “benefits in kind” such as the provision of a company car, fuel or many other items. Best to check with your accountant or on the HMRC website for up-to-date information. Employees may also find that the value of the benefit in kind is added to their personal tax or NI liabilities.

These notes are designed to give an overview of some of the issues which need to be addressed by those starting their own business. They are provided on the basis that neither the author nor the site owner are thereby engaged in rendering legal or other professional services. If legal advice or other expert assistance is required please contact james (at) jamesgreenandco.co.uk.


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Category: Starting a Business

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