Understanding Business Tax For Sole Traders and Limited Companies

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Tax is one area that many businesses could use some help. It can be too hectic to handle the day to day business and do your own books and at the same time. If you have a new business, it is next to impossible.

Despite how broad tax is, all businesses and individuals in the UK are required to pay their taxes. As you might expect, larger businesses pay more and there are different factors surrounding how much they pay. Apart from company size, the nature of the business also determines the kind and amount of tax that it pays.

Doing taxes can be daunting. And although we recommend that you hire a professional accountant or tax specialist to do your taxes, it doesn’t hurt to have an idea about business tax. In this blog, we’ll examine some business tax jargon as it concerns different company types. 

Self Employed (Sole Businesses)

Individuals who run independent companies are known as sole traders or self-employed. As a self-employed business owner, you are personally responsible for all your business expenses. This is because more often than not, the business is linked to you and does not exist as a separate entity.

In the UK, any individual who earns above one thousand pounds (£1000) from self-employment is obligated to register themselves as a business. The business owner keeps all the income earned after tax has been deducted.

The three major tax obligations for a sole business are:

1.   Income Tax

Also known as Sole Trader tax, Income tax refers to tax that you pay on the profit of your business. Since you are a registered business under law, you have to pay a percentage of your earnings as business tax. You pay income tax when your business’ profits exceed your personal allowance.

If the profits from your business exceed the 2019/2020 personal allowance rate of £12,500 for those under 75 years, and you have no other source of income, you are required to file an income tax. 

You file income tax through a Self Assessment Tax Return, a form all eligible persons have to fill yearly. The HRMC taxes sole business income and all other incomes alike. While you are allowed to take an acceptable amount of your earnings as a personal allowance, the rest  is subject to taxation; the amount depends on your tax bracket.

2.   VAT

This is one area where Limited Businesses are similar to Sole Businesses. If you run a sole business that generates over eighty-five thousand Pounds (£85,000), you are expected to register for and pay VAT. 

VAT is Valued Added Tax, and it refers to a tax placed on consumption goods whenever value is added across the supply chain. The process is free and you can register anytime you want. Once they hit the earnings target, all business have to register for VAT, whether they are at the production level or point of sale.

Currently, VAT is set at a standard rate of 20%. However, some exceptional goods are not taxable in this regard.

3.   National Insurance Contributions 

The National Insurance Contributions are not exactly taxes, but they are often regarded as such. NI is submitted by self-employed business owners through Self Assessment. This tax is necessary to qualify for certain benefits and State pension. The type of National Insurance you pay depends on your employment status and income.

Employers who earn over £183 weekly pay class 1 National Insurance and self-employed individuals with over £6,475 in yearly earnings pay Class 2 National Insurance contributions. Class 4 is for self-employed individuals with over £9,501 in profits while Class 3 are voluntary contributions to make up for tax gaps. Your marital status can influence how much you pay, so for a detailed breakdown, visit the National Insurance page. Otherwise, you can click here to hire a tax professional.

Limited Company

Limited companies are not exempt from taxes neither. There are three categories of taxes that apply to limited companies, namely:

1.   Pay As You Earn (PAYE)

Limited companies have to set up their payroll from which income tax and National Insurance will be deducted. Business directors must set up PAYE to transfer their independent salary from business accounts to personal accounts. Because the company and directors are seen as two separate entities, money may be removed from the business’ accounts at will.

Even if the director is the only employee, PAYE still needs to be set up. From this data, income tax, NI contributions, and other payments such as pensions/student loans can be deducted. NI contributions will be deducted once the employers earn over £8,424 in wages and bonuses. Proper setup for payroll management is the easiest way to handle PAYE tax.

2.   Corporations Tax

Corporations tax is charged on the annual profits of a business; it is calculated as income-allowable expenses. The tax is a flat rate, currently charged at 19%. It does not depend on your profit bracket, and there are no allowances. A CT600 form which includes company details, your tax reference number, the tax calculation, and any allowances must be completed and filed with HMRC online.

3.   VAT

VAT is the same for limited companies and sole traders. If you run a limited business, you have to pay this tax once you have reached the earnings threshold. If your turnover is over £85,000, you must register to pay VAT. Otherwise, you can register voluntarily, which may be beneficial if you sell to other registered businesses and want to claim back the VAT. You essentially collect this money from your customers and hold it until it is passed over to HMRC. The current VAT rate for businesses is 20%. 

Conclusion

Taxes are a requirement for all businesses, whether small scale or large scale. Depending on the type of business you run, the taxes you pay differ.

Get an accountant to handle all your tax calculations and payment and do away with the extra workload. Fill our form and tell us your requirements to start.

Disclaimer: We don’t take any responsibility for actions taken based on above information. Please speak to our consultants if you need more information. This guide was written specifically for FindUkAccountant clients. By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details are correct at time of writing.