What small business tax do you need to pay?

Published • 01/07/2024 | Updated • 01/07/2024

Taxes

What small business tax do you need to pay?

Published • 01/07/2024 | Updated • 01/07/2024

Taxes

Dealing with tax issues is nobody’s favourite part of running a business. But being clear on HMRC’s expectations is crucial for managing your finances, creating accurate cash flow forecasts, and ensuring you don’t find yourself penalised during a tax investigation.

Your small business tax comes down to key factors such as what your business earns, what type of business entity you have, and how your business operates. For example, a sole trader pursuing business ideas from home will have very different tax obligations to a limited company director running a café.

In this guide, we’ll break down the main small business tax types, such as small business Corporation Tax and Business Rates. We’ll discuss how they work, what the current thresholds are, and how tax breaks for small businesses can potentially boost your net cash flow.

Setting up a Government Gateway account allows you to access HMRC online services and handle matters relating to everything from Corporation Tax to VAT with ease.

Small business tax types

Whether you’re just looking into how to make money on the side or you have a brick-and-morter retail outlet, there are a number of taxes entrepreneurs should be aware of:

  • Income Tax

  • National Insurance

  • Corporation Tax

  • VAT

  • Capital Gains Tax

  • Business Rates

Income Tax

Income Tax is the biggest source of tax revenue for the UK government.How much you pay depends on your total income in a given financial year, which is the period between 6th April and the 5th April. 

For most employees, Income Tax is automatically deducted from their wages and paid to HMRC by their employers, through the PAYE system. But, if you’re exploring how to become your own boss, perhaps as a sole trader or business partner, you’ll need to handle your Income Tax payments yourself, by declaring your earnings in a Self Assessment tax return.

How is Income Tax calculated?

To work out Income Tax, simply add up all your taxable income, such as business earnings and certain state benefits, and deduct your Personal Allowance, which is the amount you’re entitled to earn tax-free. This is currently set at £12,570.

You then deduct any allowable small business expenses, such as office overheads, the cost of raw materials and marketing costs. For example, if you’re looking into how to use social media for small business success, it’s good to remember you can deduct the costs of promoted posts from your taxable earnings.

You’ll also be able to deduct the value of equipment and machinery used in your business, which are deemed capital allowances. 

Income Tax is paid on whatever amount is left, depending on the threshold you fall into:

  • £12,571 to £50,270 = 20% basic rate of Income Tax

  • £50,271 to £125,140 = 40% higher rate of Income Tax

  • £125,141 and higher = 45% additional rate of Income Tax

Bear in mind that your Personal Allowance gradually diminishes when your earnings go beyond the £100,000 mark, with no Personal Allowance permitted for those in the additional rate bracket.

Income Tax is charged at different rates if you’re in Scotland.

What is the Income Tax trading allowance?

The trading allowance is a tax exemption which allows you to earn up to £1,000 a year tax-free. What’s more, you won’t even have to notify HMRC through Self Assessment.

You can’t use the exemption if the money is coming from a business partnership or limited company, but it does apply if you’re working as a sole trader or making extra money on the side of your main job by test driving side hustle ideas.

Say you currently enjoy hobbies that make money. For example, making handcrafted pottery items which you sell at local markets and fetes a few times a year, taking payments in cash or through a portable card machine.

If you were to make under £1,000 in a given financial year, you wouldn’t have to declare this to HMRC. If you do exceed that threshold, it may be a sign that you should look into business growth strategies, such as selling your pottery through an online store.

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When do you pay Income Tax?

To pay Income Tax, you’ll have to register for Self Assessment and ensure you file your tax return online by 31st January every year. This is also the deadline for payment of the Income Tax itself, which is easily done online.

Bear in mind that if you’re in a business partnership, a designated partner must submit a separate return for the partnership itself. You’ll also have to submit your own Self Assessment return.

National Insurance

National Insurance payments are made alongside Income Tax through the Self Assessment process, and qualify you for benefits such as the state pension and maternity allowance.

If you’re looking into how to start a business, you’ll need to be aware of the National Insurance classes for self-employed people.

Class 2 National Insurance

This category of National Insurance is currently set at £3.45 per week, and is not mandatory.

If your annual profit is less than £6,725, you can voluntarily pay Class 2 National Insurance contributions to avoid gaps in your record and maintain eligibility for state benefits.

Class 2 National Insurance is considered to have been paid if your annual profit is more than £6,725.

Class 4 National Insurance

You’ll have to pay Class 4 National Insurance if your annual profit is more than £12,570. There are two thresholds:

  • 6% Class 4 National Insurance payments on profits of £12,570 to £50,270.

  • 2% Class 4 National Insurance payments on profits over £50,270.

Corporation Tax

While the simplicity of the sole trader structure is well-suited to many small business ideas, you may find that it’s worth setting up a limited company to cut your tax bill.

You’ll be able to pay yourself as a business owner by way of dividends rather than salary, incurring less tax. There are also more tax breaks for small businesses which operate as limited companies.

However, you will have to submit more detailed records regarding your small business finances, including year end accounts. Your limited company must also pay Corporation Tax.

This is a tax applied to profits made from operating activities, investments and the sale of assets like shares or property

How is small business Corporation Tax calculated?

The amount your limited company owes in Corporation Tax depends on how much profit is recorded:

  • Up to £50,000 = 19% small profits rate

  • £50,001 to £250,000 = marginal rate on a sliding scale

  • Over £250,000 = 25% main rate

To determine which rate applies to your business, you’ll need to add up all the income it has received in the year. Subtract any small business tax reliefs you may be eligible for, such as small business R&D tax credits, along with allowable expenses like overheads and salaries.

Remember that any tech you invest in for your business, such as a restaurant point-of-sale system, are capital allowances and make for valuable tax deductions for small businesses.

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When do you pay Corporation Tax?

You’ll be automatically registered for Corporation Tax when you register your limited company with Companies House online.

When it comes to how to file your company tax return, the deadline is 12 months after the end of your company’s accounting period (typically the same period covered by your annual accounts).

The small business Corporation Tax deadline for companies with taxable profits up to £1.5 million is nine months and one day after the end of your accounting period. Companies with larger profits must pay in instalments. 

Tax on dividends

If you’re doing business through a limited company, you may find it more tax efficient to limit your salary to the Personal Allowance threshold of £12,570, and withdraw the rest of your pay in the form of dividends. 

Dividends are a distribution of profits made by the company, and come with a tax-free allowance of £500 per year. The amount of tax you pay on dividends over that allowance is determined by your Income Tax band:

  • Basic rate of Income Tax = 8.75% tax on dividends

  • Higher rate of Income Tax = 33.75% tax on dividends

  • Additional rate of Income Tax = 39.35% tax on dividends

Your dividend details are submitted through Self Assessment alongside your Income Tax details.

VAT

The letters stand for “value added tax”, but just what is VAT? Simply put, it’s a tax which is added to the price of products and services by VAT-registered businesses. This money is then passed onto HMRC by these businesses.

There are three rates of VAT:

  • Standard rate, applying to most goods and services = 20% VAT

  • Reduced rate, applying to certain categories including building renovations and domestic energy supplies = 5% VAT

  • Zero-rated, applying to certain categories including most foods and children’s clothes = 0% VAT

Who has to register for VAT?

Whatever kind of business you run, whether you’re specialising in things to make and sell or exploring business ideas with low investment like providing professional services online, there are a few scenarios where you’ll be required to register for VAT (a process you can complete online).

If your taxable turnover (the total value of everything you sell) exceeds £90,000 in a 12-month period, you must register for VAT within 30 days of the end of the month when the threshold was crossed

Alternatively, if you think your turnover will cross the £90,000 threshold within the next 30 days, you must register by the end of that 30-day period. 

Say you’ve been running an online business providing graphic design services, and invoice a client for £10,000 on 6th July. You know they’ll pay within a few weeks, causing your business to cross the £90,000 threshold. This means you must register for VAT by the end of July.

While registering for VAT isn’t one of the legal requirements for starting a small business unless you know you’ll be receiving big payments from the outset, you can voluntarily register if you’re below the threshold.

Voluntary VAT for small business is something you should carefully weigh up. While it will allow you to claim back VAT you pay on products and services, it also means you’ll have to add VAT to what you charge customers. This may require rethinking your pricing strategies so you don’t lose business.

When do you pay VAT?

Businesses typically submit VAT returns to HMRC every three months, detailing how much you’ve collected in VAT, and how much you’ve spent on VAT. 

If you’ve collected more than you’ve spent, you need to pay the difference to HMRC. If you’ve spent more than you’ve collected, the difference will be refunded to you.

There are accounting tools for small business entrepreneurs which can be used to submit VAT returns, or your accountant can handle it for you. As with other taxes, VAT bills can be easily paid online.

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Capital Gains Tax

As the name suggests, Capital Gains Tax is a tax on the profit you make when selling assets such as property, equipment or shares, which have increased in value

As a small business tax, it’s payable by individuals such as sole traders, partners and company owners. Limited companies themselves don’t pay Capital Gains Tax, as any profit from the sale of assets will be covered by Corporation Tax. 

How is Capital Gains Tax calculated?

Your rate of Capital Gains Tax depends on what Income Tax bracket you fall into, and it’s important to remember that the gains themselves are factored into your taxable income, meaning that your asset sales might push you into a higher tax bracket.

  • Basic rate of Income Tax = 10% Capital Gains Tax

  • Higher or additional rate of Income Tax = 20% Capital Gains Tax

To calculate what you owe, look through your records and add up the total profit from the sales of qualifying business assets in the financial year. 

Then, deduct the Capital Gains Tax-free allowance, known as the Annual Exempt Amount, which is £3,000. The relevant rate of Capital Gains Tax is then applied to whatever is left.

When do you pay Capital Gains Tax?

Your Capital Gains Tax details can be reported in your annual Self Assessment tax return, and then paid as part of your usual tax bill. Alternatively, you can report the details through the “real time” Capital Gains Tax service online.

Small business tax relief for Capital Gains Tax

There are a number of tax reliefs for Capital Gains Tax, with the most prominent example being Entrepreneurs’ Relief.

Now formally known as Business Asset Disposal Relief, this is among the best small business tax deductions available, because it allows you to pay the basic rate of 10% Capital Gains Tax on all qualifying assets. 

It can only apply when you sell some or all of your business, rather than individual assets. You may qualify if you’re a sole trader or partner who’s owned the business for at least two years, or if you’re selling shares in a company where you’ve been at least a 5% shareholder for at least two years.

A top small business tax tip is to utilise Entrepreneurs’ Relief when drawing funds from a company which you’re closing. Instead of salary and dividends, you may reduce your tax burden by taking the funds in the form of a capital distribution, with Entrepreneurs’ Relief keeping the Capital Gains Tax at 10%.

Business Rates 

Business Rates are a form of tax charged on commercial premises such as offices, shops, pubs and warehouses. So, unless you’re exclusively interested in how to make money from home, Business Rates must be factored into your small business accounting.

Note that Scotland and Northern Ireland have their own regulations regarding Business Rates.

How are Business Rates calculated?

In England and Wales, the Valuation Office Agency estimates how much it would cost to rent your property for a year on 21 April 2021. This is your rateable value, which you can look up on the government site.

Your rateable value is multiplied by a figure known as the multiplier. In England, there are two multipliers:

  • Standard multiplier for rateable value of £51,000 and above = 54.6p

  • Small business multiplier for rateable value below £51,000 = 49.9p

In Wales, one multiplier of 56.2p applies, while the City of London has its own pair of multipliers:

  • Standard multiplier = 56.4p

  • Small business multiplier = 51.5p

To work out your Business Rates, you then deduct any small business rates relief you’re eligible for. Checking in with your local council about these reliefs should be part of your checklist for starting a business if you intend to work in a dedicated commercial workspace.

For example, you won’t have to pay Business Rates if your rateable value is £12,000 or less, while properties with a rateable value between £12,001 and £15,000, will pay discounted Business Rates on a sliding scale.

If you’re running a shop or food and drink business, you can also claim retail, hospitality and leisure relief, which could provide a hefty 75% off your Business Rates bill.

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When do you pay Business Rates?

Local councils issue Business Rates bills early in the calendar year for the upcoming tax year, and businesses typically pay in 10 monthly installments. That said, you can often request to spread the amount over 12 months, which is handy if you’d like to lower its impact on your cash flow.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.

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