Forming a limited company after starting as a sole trader is a natural next step forward for many, however, it can be a daunting experience, especially when it comes to taxes. If you have always paid your taxes through the Pay-As-You-Earn (PAYE) system previously this is quite a change. Even with the help of an accountant during the year, it makes sense to have a basic knowledge of the taxation system to help your own planning of finances.
Thankfully, we’ve put together a brief guide to help you with deciphering the wonderful world of taxes!
Corporation Tax (CT600) – Company Tax Return
Limited companies have a taxation system called Corporation Tax. This tax is calculated based on the profits the company generates during the accounting period.
Corporation Tax is declared on a Corporation Tax Return (called a CT600) which is submitted to HMRC within 12 months of the year-end of the company. Payment is due within 9 months of the year-end and so it is important to ensure you know what you are paying before then. The tax is generally paid in one lump sum. A company’s accounting year-end is naturally the end of the month a year after you have incorporated your company and continues as the end of the same month for every year after.
Read more on our latest Corporation Tax guide
Corporation Tax is declared on a Corporation Tax Return (called a CT600) which is submitted to HMRC within 12 months of the year end of the company. Payment is due within 9 months of the year end and so it is important to ensure you know what you are paying before then.
Value Added Tax (VAT)
VAT is an indirect tax that businesses charge on their sales. VAT is voluntary when income is below the VAT threshold. However, once income exceeds the threshold all business must register for VAT unless they are deemed exempt.
Not all products and services are subject to VAT so not every business can charge VAT.
Once registered for VAT, you submit VAT returns to HMRC usually on a quarterly or annual basis. Although you must charge VAT on the sales you generate, you are able to claim back VAT on the products or services you purchase. This means that when completing the VAT return you pay the difference in the amount you have charged against the amount you have been charged by your suppliers.
There are various VAT schemes on offer to help your business manage VAT, here is the summary of the most common:
Declaring VAT on the invoices you have sent and received during the VAT period is known as the Standard VAT Scheme.
Declaring VAT when you make a payment against an invoice or when a customer makes a payment against your sales invoices is called the Cash Accounting Scheme.
The Flat Rate Scheme is a scheme set up to make the calculation of VAT easier. A percentage is used based upon gross income (income including VAT) during the VAT period, but no amount is taken on purchases unless it is an asset purchased for over £2,000 including VAT. The percentage is specific to the industry that you operate in unless you are deemed a limited cost trader. If you are a limited cost trader, then you must use 16.5% as your percentage (although you do qualify for a 1% first-year discount in the first year of VAT registration).
Finally, the Annual Accounting Scheme is when the VAT is paid monthly or quarterly during the year but is based upon the previous year’s VAT liability. When the VAT return is submitted at the end of each year a balancing payment, or refund is then duly paid/received.
The Flat Rate Scheme is a scheme set up to make the calculation of VAT easier. A percentage is used based upon gross income (income including VAT) during the VAT period, but no amount is taken on purchases unless it is an asset purchased for over £2,000 including VAT.
Income tax is paid by individuals, either as an employee through PAYE or through Self-Assessment for business owners and anyone with untaxed additional income. If you operate a sole trader or partnership business you will pay Income Tax through Self-Assessment. This tax is calculated on the profits you have earned through running your business during the tax year. The tax year for Self-Assessment is always to the 5th April.
The taxes are declared through the completion of the Self-Assessment Tax Return each year. Except for the first year when the tax due is paid in one lump in January, the tax is paid in two instalments called payments on account in January and July with a balancing payment payable in the following January.
As a director of a limited company, you will also fall under the Self-Assessment tax system if you draw out dividends or earn other income over and above your declared wages. There is a dividend allowance that everyone is entitled to that is tax-free, above this, the tax rate that applies depends on your other income.
Everyone has a tax-free personal allowance of income they can earn without being charged tax. As a business owner, you are still eligible for this allowance. This means that any income generated up to the tax-free threshold is tax-free each year. However, if you are lucky enough to be earning above £100,000 your personal allowance will start to shrink by £1 for every £2 over £100,000.
Income tax is calculated based upon the level of profits earned in the business together with any other forms of income during the year. A percentage is used to calculate the tax with different bands being used for increasing levels of income.
If you or your partner receive child benefit and you are the higher earner and have an income of over £50,000 then a percentage will need to be paid back. When your income reaches £60,000, 100% of the child benefit will need to be paid back.
If you have a student loan that needs repaying, your total income is considered to calculate the amount repayable each year. This includes the profits if you are a sole-trader or partnership and dividends if you are operating through a limited company.
As a director of a limited company, you will also fall under the Self-Assessment tax system if you draw out dividends or earn other income over and above your declared wages.
National Insurance is regarded as another form of taxation and is payable by any employee, employer and any business owner earning over and above the National Insurance threshold.
There are different types of National Insurance depending on whether you are an employee, employer or business owner. However, we’ll look at business owner related ones.
Class 2 National Insurance is paid by all business owners earning above the National Insurance threshold and is paid as part of your Self-Assessment Tax bill. Class 4 National Insurance is also paid by business owners earning above the National Insurance threshold. Similar to Income Tax, it is charged on a percentage of your business profits and is payable together with Income Tax on the Self-Assessment tax form.