9th March, 2021
Small business taxes: what, when and how to pay
If you’re self-employed or starting a small business, find out everything you need to know about UK small business taxes – including how and when to pay.
Income tax: How much, when and how?
As a sole trader you will pay income tax on your business’s taxable profit (sales minus costs and allowances), which will be calculated after you file your Self-Assessment tax return, detailing your sales revenue and outgoings.
However, you won’t pay any income tax if the total of your taxable earnings (which will take into account other earnings such as dividends, savings interest or capital gains) is below the standard tax-free personal allowance (£12,500 for 2020-2021 if you are under 75 years old). Keep in mind that this threshold will be lower if your total taxable income exceeds £100,000, or if, as a basic rate taxpayer, you claim a marriage allowance. For more information see the HMRC website.
The income tax rate that will apply will depend on the amount of your business’s annual profit combined with any other taxable income:
- If this amount falls in a range between £12,501 and £50,000, you will pay the basic income tax rate of 20%.
- If it falls in a range between £50,001 and £150,000, you will pay a higher rate of 40%.
- For profits and other taxable income over £150,000, an additional rate of 45% will apply.
If you operate your business through a limited company, you will also pay income tax on any salary or dividends you take from the company.
What about National Insurance?
Although the National Insurance is not technically a tax, the National Insurance contributions (NICs) you will have to pay as a sole trader or a limited company is still money you will pay to the government. You will pay this at the same time as your income tax, after completing your Self-Assessment tax return.
There are two kinds of NICs. First, unless your business’s profits are under the Small Profits Threshold (£6,475 for the year 2020/2021), a sole trader can pay a flat weekly rate of NI called Class 2 NIC, which amounts to £3.05 per week in 2020/2021. There is also the possibility to pay Class 2 NICs voluntarily, even if you are under the aforementioned threshold, to protect your entitlement to State Pension and other benefits.
The second kind of NIC that you might pay as a sole trader is called Class 4 NIC, and applies if your business’s profits are between £9,501 and £50,000, at a rate of 9%. The rate will be at 2% for any further profits over £50,000 (2020/2021 rates). For more information on Class 2 and Class 4 NICs, see the Gov.uk website.
If you’re running your business as a limited company, and you are employed by the company, your NICs will be taken automatically through payroll, through the Pay As You Earn (PAYE) scheme. If the company employs other people, you will need to pay the employer’s portion of NICs directly to HMRC. In 2020/2021, NICs for employees with earning above £9,500 per year is 13.8%. Nevertheless, your NICs will be reduced by up to £3,000 if your business is eligible for the Employment Allowance, which applies to all organisations with NICs of less than £100,000.
The Gov.uk website has online tools which allow you to check your payroll calculations for NICs.
The Value Added Tax (VAT)
VAT is a tax that is added to most goods and services. Whether you run your small business as a sole trader or through a limited company, if you make VAT taxable turnover (sales of goods or services that would have VAT charged on them if made by a VAT-registered business) of more than £85,000 a year (in 2020/2021), you will have to register your business for VAT. See more on this at Gov.UK.
The standard rate of VAT is 20% and applies to most VAT taxable goods and services, while the reduced rate of 5% applies to a limited set of goods (such as home energy and children’s car seats). There is a 0% rate for exceptional goods.
You can recover what you paid by charging your customers VAT on top of your prices, and by reclaiming VAT that you pay on business expenses.
If your turnover is below the aforementioned threshold of £85,000 a year, you can still pay VAT voluntarily which will enable you to reclaim it later.
VAT returns should be submitted every three months, even if there is no VAT to pay or reclaim.
To help businesses avoid financial hardship during the coronavirus outbreak, the British government is deferring VAT payments due before 30 June 2020 until 31 March 2021. This measure applies to business which are VAT-registered in the UK and that have a payment due between 20 March 2020 and 30 June 2021.
Although UK-based companies and sole traders would usually only need to register for VAT in the UK, there is an exception if you provide digital services to consumers in EU countries over a certain value threshold each year. Find out more on Gov.UK.
What about corporation tax?
As a sole trader, you won’t have to pay corporation tax, as it’s only applied to the profits made by limited companies.
There’s no equivalent of the personal allowance that applies to the income tax, so the company will start paying corporation tax as soon as it makes profits, unless it’s previously made losses.
Currently, corporation tax has a flat rate of 19%.
Limited companies need to pay their corporation tax bill nine months and one day after the company’s accounting year ends.
Regarding business rates, you will only need to pay those if your business has a physical presence in a commercial property such as shops, warehouses, industrial units or factories. As such, it won’t apply to online-only businesses.
Sole trader or limited company?
Is it more efficient to operate your business as a sole trader or as a limited company?
Despite setting up as a sole trader being the most popular option for small businesses owners – in 2019, sole traders accounted for 59% of small businesses in the UK – there are some advantages on a tax level to having a limited company.
Remember that a sole trader will have to pay income tax on all the profits that are above the personal tax allowance (of £12,500 for the tax year of 2020/2021) whereas a limited company will only pay corporation tax on its profits. If your income as a sole trader would put you into the higher rate tax band, for example, it could be more tax-efficient to operate as limited company.
Don’t forget, however, that tax efficiency is only one aspect to take into account when deciding whether to set up your business as a limited company or not. Another factor to take into account is personal liability, as a limited company creates a legal separation between a business owner and their business. There’s also the additional administrative complexity that comes with setting up and operating a limited company, and the fact that a limited company is publicly searchable via Companies House.
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