Small Business Tax Planning

All you need to know from start-up to retirement

Russell Cockburn

• Publisher: Harriman House
• Year: 2011
• ISBN:
  9780857192097
• Topic: Betriebswirtschaft
• Subtopic: Besteuerung

Effective planning of your tax affairs to help your business save moneyEvery profitable business in the UK has to pay tax, but some small businesses pay more tax than is necessary. This book examines the tax liabilities that the owners or managers of small businesses need to bear in mind and explains how to manage these tax requirements in the best possible way so as to avoid paying more tax than you have to.Uniquely, this guide traces how tax should be dealt with throughout the life-cycle of a business, from start-up to the time it is sold, wound up, or passed on, so that whatever stage your business is at this book will be valuable for you.Areas that are covered include: - What business structure you should choose when starting out: self-employed sole trader, partnership or limited company.- How to register your business and when to start paying tax.- When tax inspections might arise and how to deal with them.- How to manage business expenses effectively and make use of relevant tax benefits.- How to withdraw from a business and pass it on, or how to go about selling it.Guidance about tax is spread over many different locations; on the internet, in booklets provided by HMRC, and in magazines and annual publications. Russell Cockburn brings the information together in this simple and incisive summary enabling you to approach your tax affairs as efficiently as possible.

Part One. Setting Up A Business

1. Business Structure – Choices and Tax Implications

On business structure

Many businesses do not give much consideration to their structure at the start-up stage. This is a mistake. The structure chosen at the outset will largely determine how and when the first, and all subsequent, tax bills arise, what tax planning techniques can be brought to bear and what opportunities there are for mitigating tax liabilities. The business structure can be changed later on but that can be a lot more expensive than getting it right from the outset.

Selecting the right business entity

Take some time to consider what business structure will be right for your venture before you begin. The choice might appear obvious but sometimes making the wrong decision at the start can have a significant negative affect on the success of the business for years to come. The alternative structures available differ considerably in their tax implications and so the choice you make will affect how much tax and National Insurance Contributions (NIC) you pay in the future and when you will pay them.

There are a range of choices available for a trading venture and in this chapter we will look at the following:

• Sole trader
• Partnership
• Small limited company

Before deciding upon one of these options, the questions you should ask yourself are:

• What trading entity should I use?
• What are the alternatives?
• What will be the different tax implications and when will tax be due?
• Do different structures offer differing planning options?
• Can I easily change structure once I have made the initial choice?

This chapter will provide you with the necessary information to help you choose.

Changing the business structure

Many businesses move from one type of business structure to another as they grow. They may take in a partner or outside investor or involve a family member as a tax-effective move.

The change from being a sole trader in self-employment to using a limited company structure is probably the most common seen in the small business world, but it might be better to adopt a small limited company structure from the outset. Getting this choice right requires some careful thought and a good look at the tax implications of the alternatives that are available.

Sole trader

Introduction and definition

For the individual with a business idea and the skills to put it into operation the most common choice is simply to set up as a self-employed individual; to become a sole trader.

A sole trader, or sole proprietorship, is one where the business and the owner are indistinguishable: the owner has unlimited liability for the business because they are the business. The business may be named after the owner or it may run under a specific trade name, thus Russ Cockburn might trade as “Russ Cockburn – Plumber” or he might use the trade name “Incredible Plumbers & Co”. Whatever the name, the identity of the business is that of the proprietor, and the person running the business is that business. Legally the two are one and the same.

This form of business structure has the benefit of simplicity because it is relatively easy to set up and run. It is also likely to be the most appropriate choice for the smallest of enterprises. Indeed, some people start a business almost without realising it. The transition from enjoying a hobby to running a small business can often be a gradual and almost unnoticed change that occurs whilst the individual is employed by someone else in a permanent role.

Setting up as a sole trader requires minimal form filling and has relatively few compliance obligations in comparison to other business structures. For example, as regards initial interactions with the tax authorities, the simple form CWF1 is used to notify the start of the business for both income tax and NIC.

But is setting up as a sole trader the correct choice?

All too often business are started without giving some attention to the alternative business entities that are available.

There will be some types of business for which a sole tradership may not be the right choice. A business with a high level of commercial risk or potential product liability problems would probably be better advised to start using a limited company structure in order to give the proprietor more legal protection in the case of errors or faults arising in the course of running the business.

Some small businesses are effectively forced to run their activities through a limited company as their customers will not use subcontractors who are not incorporated; this is common, for example, in the professional contracting industry where many large end-users insist that their subcontractors operate via their own limited companies.

Businesses which expect to make significant profits from the outset will also need to consider at the start-up stage whether or not using a limited company will offer them business and personal tax mitigation opportunities. This is discussed later in this book.

Immediate tax and compliance implications

The early days of a sole trader’s business must involve some basic compliance activities to ensure that the business gets off on the right footing with the tax authorities. Much of this can be done online.

The business has to notify HMRC that it has commenced trading and this must be done within three months of the end of the month in which the business starts up, otherwise there can be a fine (currently £100) for failure to notify for NIC purposes.

There is a second deadline of the 6 October after the end of the tax year in which the business starts up for income tax purposes as well. Failure to notify within this deadline can carry a tax-geared penalty, so telling the authorities that the business has commenced is very important.

A business that expects to exceed the VAT threshold (currently £70,000 turnover per annum) will also need to register with the tax authorities for VAT so as to avoid late-notification penalties. There are some other criteria to be reviewed and HMRC provides a VAT registration tool on its website to assist with this (www.hmrc.gov.uk/vat).

There may also be other tax registration obligations if the business is to employ staff or construction industry subcontractors, because regular returns for these individuals have to be submitted and tax deductions may have to be made from their earnings and accounted for to the tax authorities.

A business that uses a tax adviser, perhaps an accountant, will need to make information about the start-up date available to the adviser so that they can make prompt notification to the tax authorities to ensure any penalties are avoided.

Once registered, a business will then need to prepare annual accounts and submit an annual self-assessment tax return to HMRC. To facilitate this process the trader will need to start keeping proper records of all business transactions, income and expenses, and ensure that these records will be adequate for the purposes of preparing proper accounts after the end of the business’ first financial year, or possibly sooner if the accounting date chosen is earlier than this.

The HMRC website has a specific section on starting up a business (www.hmrc.gov.uk/startingup).

Hidden implications

Deciding to start in business as a sole trader means that you have already made important choices – changing your business structure from sole tradership in the future may bring tax consequences.

If you convert your business to a partnership later on this may entail passing over a share in the business assets or goodwill to the new incoming partners. Whilst this is not normally a major issue, it will have to be considered carefully at that stage and specific tax advice will be needed as there can be capital taxation implications to overcome.

If you convert the business to a limited company as it grows, this will probably prove more expensive than would have been the case had the business been run as a limited company from the outset. Some businesses never grow that large or never need limited company status, but it should be recognised that converting a business from a sole tradership to a limited company vehicle can bring tax consequences which have to be managed at that stage. These are not normally insurmountable and in most cases the transfer can be accomplished without painful tax liabilities arising, but again specific tax advice will be needed to accomplish this transition smoothly.

Taking profits and paying tax from a sole tradership

Profits can be extracted easily

A sole tradership offers you ease of extraction of profits from the start. There are no specific laws about when the proprietor can take money out of the business (although of course running up an unauthorised overdraft will not go down well with the bank manager).

The ability of a sole trader to withdraw profits from the business at their own discretion differs from the shareholder in a limited company, as will be discussed later. This means that the sole trader is sometimes regarded as having significantly more flexibility and control over their own finances, with fewer tax complications.

When to pay tax

A sole trader is taxable on their profits, which have to be computed according to normal commercial accountancy principles. It is sensible to make early provision for tax liabilities.

If the business is going to be profitable straightaway then it will be vital to have a clear idea of when the first tax bills will be payable. Income tax falls due on 31 January and 31 July each year as payments on account. Payments on account are normally set at 50% of the previous year’s income tax liability so there are no payments on account during the first year of a business’ existence as there will be no such prior year. Thus, for example, a business commencing on 1 January 2010 will have its first tax bill falling due on 31 January 2011.

The final tax liability for any tax year is paid on 31 January after the end of the tax year. Thus the final payment for tax year 2010/2011 falls due on 31 January 2012, with two payments having been made on 31 January 2011 and 31 July 2011.

The sole trader will also be liable for two separate rates of National Insurance, known as class 2 and class 4 NICs. Class 2 is payable monthly by standing order to HMRC and class 4 is payable on the January and July payment dates based on the submission of the annual self-assessment tax return. (For the applicable tax rates and amounts see the appendices.)

As a business grows, its turnover may rise above the registration threshold for value added tax (VAT) and so it may also need to register to charge VAT on its goods and services and for the submission of VAT returns. This threshold applies whether or not the business is incorporated. The 2010/11 VAT registration threshold is turnover of £70,000 per annum and this means that the business must register for VAT if the supplies it has made in the past year, or in the next thirty days, exceed this figure at the end of any month unless turnover is not expected to exceed £68,000 in the next year (the de-registration threshold).

Tax advantages and disadvantages of sole tradership

Advantages

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