What taxes do small businesses have to pay?

Getting your head around tax can be tricky if you’re a first time business owner. After all, at a time when you want to focus on getting your business off the ground, taxes can be easy to overlook. However, with potential financial penalties and, in extreme cases, even criminal charges for those businesses who fail to pay their taxes, it’s crucial all business owners understand what they need to pay and when.

In this guide, Caunce O’Hara looks at the various taxes your small business may be required to pay. This will include a run through of all common taxations and when in the year they are due. We also take a look at how your chosen business model impacts which taxes affect you.

How much tax do small businesses pay in the UK?

The amount of tax a small business is required to pay in the UK depends on a range of factors. These include how large your business profits are, what industry it operates in, and whether or not you employ any staff. The manner in which you trade can also impact your tax obligations. This is to say, if you operate as a sole trader, a partnership or a limited company. We will look at this in more detail later.

However, just as with small business insurance policies, there are certain types of tax all owners need to be aware of. These are:

Corporation tax

This will impact your business if it is a limited company and focuses on profits, so, as soon as your corporation tax is submitted and shows a profit, your business will pay corporation tax. It’s important to note that this tax applies to profit made from the sale of assets as well as those made from trading.

In order to pay this tax, limited companies are required to calculate their own tax liabilities. It is due to be paid to HMRC nine months after the company’s accounting year. For example, if your business’ year ends on 31st March, your corporation tax will be due by 1st January. For context, in the 2022/23 financial year, corporation tax is set at 19%. However, this is set to increase to 25% from the start of the 2023/24 financial year for companies with profits over £250K. Companies with profits between £50K and £250K will pay the main 25% tax rate, but this will be reduced by a marginal relief to provide a gradual increase in the effective corporation tax rate. Nevertheless, the trend is upwards.

Income tax

Income tax is paid on any personal income. When it comes to small business owners, it will depend upon how you trade.
If you are paid a salary you will pay PAYE; however, if you are a shareholder of your limited company and also receive dividends, you will pay income tax on these (but no National Insurance). As we will touch on below, sole traders and partners in partnerships pay income tax based on the overall profit their business makes, and this income will be entered on the self-employment pages of your self-assessment tax return.

The current tax-free allowance for the income tax year is £12,570. This means, if your total income (from all sources, including business profits) is less than this, you are not required to pay any income tax. However, if this is the case, you still need to complete an HMRC self-assessment return.

National Insurance Contributions (NICs)

Although not strictly a tax, National Insurance is still a regular financial contribution you are required to make to the government. Money collected ultimately goes towards government-run pension funds and public services like the NHS.

For directors of limited companies, NICS are paid in the same way as income tax – via a business’ PAYE scheme. For sole traders the process is slightly different. You are required to account for your own NICs and declare it on your HMRC self-assessment tax return. The size of your contribution depends on the size of your business profits.

VAT

Value Added Tax (VAT) applies to businesses that make sales of goods and/or services of more than £85,000 a year. If this is the case, you legally have to register your business for VAT. If your annual turnover is less than £85,000, registering for VAT is optional. While registering may help your business appear more professional, there are downsides. For example, you may end up having to increase the prices of your products and services to cover the extra tax bill.

If you are required to pay VAT, it needs to be paid quarterly. With this in mind, all VAT returns must be submitted to HMRC within one calendar month and 7 days of the end of the VAT period.

Business rates

All types of businesses may be subjected to business rates. Collected by local councils on behalf of the government, this ‘tax’ relates to business premises. Based on location, value and size of the property, this is the business equivalent of domestic council tax. It’s important to note, even if your business does not have a traditional brick-and-mortar shop, you may still be subjected to business rates; for example, if you sell goods or services to customers who visit the property for that purpose. However, if you only use a small area of your home for your business, you don’t typically have to pay business rates.

Tax obligations based on structure: an overview

As we have seen above, not all businesses are required to pay every form of tax. A business’s tax obligations can come down to their specific structure. Below we provide a quick overview of what each type of business needs to pay.

Sole traders

Sole traders may have to pay some or all of the following taxes: income tax, NICs, VAT and business rates. They do not pay corporation tax. When it comes to income tax, NICs and VAT, the amount due comes down to the turnover of your business. As touched on above, a sole trader’s tax-free personal allowance is £12,570. If your business makes less than this a year (on top of any other personal income you, as the owner, see) it will not be required to pay income tax. Similarly, with VAT, you are only taxed if your business earns over £85,000 per year.

Remember, as a sole trader, it is your responsibility to complete a self-assessment tax return each year. This document will detail all of the above, as well as help you calculate and pay your business’ NI contributions.

Partnerships

Small businesses that operate as partnerships have similar tax obligations to sole traders. All partners must pay income tax based on business profits in the same way as sole traders. A ‘nominated partner’ must also submit a self-assessment tax return to HMRC each year detailing profits and calculating the business’s NI contributions. As for VAT, this also only applies if the business turns over more than £85,000 a year (or voluntarily registers for VAT).

Limited companies

Limited companies are potentially subjected to all the taxes discussed above. This includes paying corporation tax on the company’s profits and submitting an annual tax return to Companies House.

As a director of a limited company, you are required to complete a self-assessment tax return. Depending on your income, this could see you subject to both income tax and NI contributions, payable through your business’s PAYE scheme.

If you are also a shareholder in the company, you can be paid dividends which is a way for companies to distribute their profits to shareholders. Dividends attract income tax, but not NICs and so this is a very tax efficient way of remunerating yourself if you are a business owner.

Finally, companies must also register their business to pay VAT if the company has a turnover of more than £85,000 annually.

Do I need tax investigation cover?

HMRC has the authority to investigate a business’s tax affairs at random, without any prior warning. These checks can be very specific looking at only certain aspects of a tax return of the business or a ‘Full Enquiry’ where HMRC are essentially challenging the whole of the tax return. Either way, the compliance check will be detailed, time consuming and expensive to deal with to defend your position, even when your return might subsequently be given a clean bill of health. If, however, discrepancies are found – intentional or not – you will be charged interest, potentially face penalty fees and in extreme cases, even criminal charges. However, if you have specialist tax investigation insurance in place, you can save yourself money, time and anguish.

Here at Caunce O’Hara, our legal expenses and tax investigation insurance policy costs £75 a year – providing you with access to advice, consultancy and defence representation from highly skilled and experienced ex-HMRC tax investigations specialists. You could potentially save thousands in professional fees and protect your business’ finances.