Understanding your tax responsibilities as a small business owner

When you’re starting your own business in the UK, it’s crucial to understand your tax responsibilities.

In this article, we’ll sum up what you need to know and go through the different obligations different business structures have.

When do I need to pay my taxes?

Different forms of tax have different payment schedules. The Income Tax and Payroll Tax year runs from 6 April to 5 April. If you complete a Self Assessment then you will make a payment twice a year.

The deadlines for paying your Self Assessment tax bill are:

• 31 January - any tax you owe from the previous tax year (also known as a balancing payment) and your first payment on account for the current tax year

• 31 July - your second payment on account

What are the different forms of tax?

While there are more specific types of tax, the ones you’ll most likely need to worry about as a small business owner are as follows.

• Payroll Taxes are paid monthly. These are incurred if you employ anyone, or if you employ yourself, through a PAYE scheme. 

• Income Tax is paid on any income you receive personally which has not been paid via a PAYE scheme. This includes the dividends you might receive if you’re registered as a Limited Company. The Income Tax you owe is calculated in your Self Assessment return.

• National Insurance pays for public services and your state pension. You pay it personally on Self Assessment, and employers contribute for their employees.

• Value Added Tax (VAT) is an indirect tax. Most purchases and sales will have VAT depending on what type of goods and services are being bought and sold. Businesses must register for VAT if their turnover exceeds £85,000 - if your taxable turnover is below £85,000, you can register voluntarily. Unlike other taxes, VAT is usually paid quarterly.

• Corporation Tax is paid on the profits of limited companies, limited partnerships and limited liability partnerships (LLP).

Sole trader tax responsibilities

1. Keep records of your business’s sales and expenses

The first thing you’ll need to do as a sole trader is keep records of your business’s earnings and expenses. This is so you can report the correct amounts to HM Revenue and Customs (HMRC) – and pay the right amount of tax on what you earn.

2. Send a Self Assessment tax return every year

As a self-employed sole trader, you’ll need to register with HMRC for a Self Assessment tax return.

While the details can seem complicated, the overall gist of Self Assessment is simple: you report your earnings and expenses and HMRC then calculates how much tax you owe on your net income.

The simplest way to fill out your return is online, and this also gives you a later deadline: where paper returns must be submitted by 31 October, online submissions aren’t due until the following 31 January.

3. Pay Income Tax and Class 2 and Class 4 National Insurance

As your finances and those of your business are, legally speaking, one and the same, as a sole trader everything you earn by doing business counts as income for tax purposes.

The tax bands for tax year 2021-22 are as follows:

• tax-free personal allowance: up to £12,570 

• £12,571–£50,5270: 20% 

• £50,271–£150,000: 40% 

• over £150,000: 45%

If you are subject to Scottish Rate of Income Tax you can find the tax bands here.

As these are marginal tax bands, they only apply to the portion of your income that falls within the band.

The self-employed must usually pay Class 2 and Class 4 NICs, in the following bands:

Class 2 Paid on annual profits above £6,475 £3.05 per week

Class 4 Paid on annual profits above £9,501 9% of profits between £9,501 and £50,000 and 2% of profits above £50,000

Completing the Self Assessment process will tell you how much you owe in each of these categories. After that, you’ll have a few options for how you pay, including by cheque, deposit or bank transfer.

Limited company tax responsibilities

All limited companies

1. Keep accounting records

To ensure you’re paying the right amount of tax, you need to keep regular accounts. This ties in with your obligations to file accounts with Companies House and file tax returns with HMRC. The easiest way to keep on top of this is to use HMRC’s online software to do both at the same time.

2. Pay Corporation Tax

All limited companies pay Corporation Tax on their profits.

You must register your company with Companies House to get set up to pay Corporation Tax. Then, you must fill out your Corporation Tax return (CT600) and pay within nine months and one day of your company’s ‘normal due day’ – usually the anniversary of when your company was formed.

If your company is based in the UK, you pay Corporation Tax on all profits you make in the UK and abroad. Taxable profits include money you make from investments and from selling assets for more than they cost, as well as your regular trading profits.

The current Corporation Tax rate is 19%.

Some limited companies

1. Pay VAT

All companies that make £85,000 or more in any 12-month period are required to register for VAT. 

While there are a few different schemes you can use to pay VAT, the general principle is the same: you charge VAT on the goods or services you provide, you then off-set the VAT you pay to your supplies for goods and services. You keep track of the net amount and pay it to HMRC.

VAT is usually paid quarterly by the 7th of the following month after the quarter ends. For example, if your VAT quarter is February to April, then you must submit your return and pay HMRC by 7 May.

2. Deduct Income Tax and NICs

If you have any employees, or even if you pay yourself a salary as a director, you need to pay Income Tax and NICs.

If you have registered as an employer with HMRC you have an obligation to pay Payroll Tax by operating PAYE and send a Full Payment Submission (FPS) to HMRC on or before every pay date, whether you pay yourself every month (or week) or pay other employees.

Depending on the payments made you will have to deduct Income Tax and National Insurance from the employee (or yourself) and also pay Employers National Insurance. There are other obligations such as providing pensions (depending on the employee’s age and wage) and statutory payments.

The tax year runs from the 6th April to 5th April and is split into 12 tax months. You must pay HMRC by 19th of the month following a tax month e.g you pay an employee 30th June which falls into tax month 5th June to 7th July. The tax and National insurance due is paid by 19th July.

Remember: even if no one is getting paid enough to qualify for Income Tax or NICs, you still need to report to HMRC, unless all employees are paid below the National Insurance lower earnings level, which for 2021-22 is £120 weekly (or the equivalent monthly/annual values).

3. Pay tax on dividends

Why is this better than taking all your money as salary? Because it lets you keep more of the money.

While dividends are taxed at three different rates dependent on the Income Tax band your earnings fall within, you don’t need to pay NICs on them.

In addition, you also effectively get a 10% tax credit when you draw dividends, as Corporation Tax has already been deducted.

4. Pay capital gains tax

You pay capital gains tax on any assets you sell for more than you bought them for, though some assets are tax-free. Only the gain you made is taxable, so you won’t need to pay tax on the full price you receive for the asset.

5. Register for Self Assessment

Finally, as a director, you’ll need to submit a Self Assessment tax return for your own earnings, including salary, dividends and anything else.

6. Make payments on account

You may also need to make payments ‘on account’. Put simply, if your tax bill is over £1,000 and you haven’t paid more than 80% of the tax you owe directly, you need to make a payment towards the following tax year.

This is a strange system, and while it can take some of the stress out of paying your tax bill in one lump sum, it really exists to make things easier for HMRC, ensuring they get some money in the current tax year.

Accountants: recommended but not required

At this point, it’s worth considering whether you ought to hire an accountant.

The answer will depend on a few factors: the size of your business, the sorts of tax you’re paying and even your personal preferences.

In some cases, you might want to hire an accountant on a temporary basis, to help you out when the time comes to sort your accounts at the year end. If you do choose to hire one, you can appoint them as your ‘agent’ to deal with HMRC on your behalf.

Limited partnership and limited liability partnership (LLP) tax responsibilities

While LLPs differ from limited partnerships in some key ways, the tax responsibilities are similar for both business structures. We’ll note any important differences in the relevant sections below.

1. Keep company records and report changes

Both types of partnership must be registered with Companies House. LLPs must also send general accounts to Companies House. Limited partnerships only need to do so if the general partner is a limited company, but it is of course still useful to keep good records.

LLPs will also generally need to appoint an auditor for each tax year, but you can claim exemptions as a ‘micro-entity’ if your business is small enough.

To claim audit exemptions, your business must meet at least two of the following criteria:

• annual turnover of less than £10.2 million 

• total balance sheet of less than £5.1 million 

• fifty employees or less on average

LLPs will also need to send a yearly confirmation statement, previously known as an annual return, to Companies House.

2. Pay Corporation Tax if needed

One of the key benefits of a partnership structure is that usually it’ll be ‘tax transparent’. This means that the partnership itself does not pay any Corporation Tax. Instead, partners are taxed individually on the share of income and gains they receive. 

Corporate partners, however, may need to pay Corporation Tax, so it’s worth keeping this in mind when choosing your business structure.

3. Register for and pay Self Assessment

Where each partner in an LLP must register for Self Assessment and pay taxes on their share of profits and losses, this only applies to the general partner in a limited partnership. The process is the same as for the self-employed, as are the income bands and NIC payments; see above for more detail.

4. Register for and pay VAT

As with limited companies, limited partnerships and LLPs must register for VAT if they are likely to turn over more than £85,000 in any given 12-month period. Once again, see above to learn more.

Start your business off right

We hope you’ve found this summary of the different tax responsibilities of different types of business owners. It can be a lot to figure out, but it’s one of those things that’s absolutely worth getting your head around – after all, the last thing you want is to fall foul of HMRC.

Needless to say, there is a lot more to starting your own business in the UK than paying tax. Fill out this questionnaire to check if you’ve taken all the necessary steps to starting your business off right.