On setting up a new business, the first choice for the owner is the status of the company and how this will impact on their tax contributions. Many new business owners, especially if they plan to work on their own for some time will opt for sole trader status as it involves less paperwork and their only obligations are to organize their own income tax and national insurance contributions. However, many owners with previous experience of running their own business choose to form a limited company instead. This makes the company a distinct legal entity of its own with the owner as a director claiming a salary. This has the advantage of keeping the financial affairs of the director and shareholders separate from the company and means their property is not at risk as financial liability is on the company.
The director is obliged to register the company with Companies House and give it a distinct name which is protected from use by other companies. The director is directly responsible for all tax matters and must submit a copy of the annual accounts and an annual confirmation statement. With this in mind, if you are planning to set up a limited company, it pays to be aware of which taxes you are likely to pay. It is always recommended that an accountant be employed to deal with company taxes to ensure that correct information is being returned to HMRC as incorrect payment could be construed as fraud and can carry severe penalties.
Within three weeks of establishing a limited company, HMRC will automatically send the director a Corporation Tax registration form, which must be completed and returned within three months of starting to trade. If you have an accountant they should keep accurate accounting records from the outset and prepare a company tax return. After nine months and one day of the trading year any Corporation Tax owed must be paid or if you have nothing to pay it should be reported at this time. Company tax returns must be submitted twelve months after the end of your previous trading year. No bill will be issued for Corporation tax, it is the responsibility of the director to ensure it is paid. Corporation Tax is paid on all trading profits, investments and sales of assets and is currently calculated at 19% regardless of the size of the business. However, this will be reduced to 17% in 2020.
Value Added Tax (VAT)
If your business has a turnover in excess of £85,000 you are legally obliged to register for VAT. The company will then be provided with a VAT registration certificate which contains the company VAT number and the date when the first VAT return is due. Once registered you will be required to charge VAT on all goods and services your company provides but will have the added benefit of being to reclaim VAT on goods and services purchased by your company. VAT is an unusual tax as the company is required to pay it to HMRC but it will already have been charged on goods and services provided by the company. In effect, the company collects VAT on behalf of HMRC and passes it on rather than the Government collecting it directly. VAT can be calculated on each individual item sold, or, as this is time-consuming and complex, a flat rate can be applied across all turnover. It is worth consulting an accountant on which option best suits your individual company as VAT laws can be complex and they will have greater knowledge of which VAT scheme would be the most suitable to register for.
National Insurance (NI)
Any salaries payed to company employees must have National Insurance Contributions (NICs) deducted by the employer and paid to HMRC on a monthly or quarterly basis. Some companies are eligible under the Employment Allowance tax initiative to write off the first £3,000 of Employers National Insurance contributions and it is worth having an accountant investigate if this is the case. Class 1 NI contributions must be paid to be the employer and employee on earnings above the minimum threshold. For the 2018/ 2019 tax year the percentages for these were as follows:
- 8% on salaries above £162 per week
- 12% on salaries between £162 and £892 per week
- 2% on salaries over £892 per week
All employers and directors that take a salary from the company must pay Income Tax on all earnings above the Personal Allowance of £12,500. As a result, many directors will only pay themselves a small salary and most of their earnings will be made from dividends (discussed below). For all individuals earning a salary above £12,500, the tax bands are:
- Basic rate (12,501 – 50,000) – 20%
- Higher rate (50,001 – 150,000) – 40%
- Additional rate (over 150,000) – 45%
Dividends are payments made to shareholders after a board meeting to declare the dividend. Minutes should be kept of this meeting even if there is only one director and a dividend voucher issued to all recipients stating the amount of payment and date it was declared. Dividends are paid out of profits after corporation tax and can be paid as interim dividends throughout the year or final dividends at the end of the financial year. Dividend payments are tax-free up to £2,000, after this the percentages are:
- Basic rate (up to 45,000) – 7.5%
- Higher rate (45,001 – 150,000) – 32.5%
- Additional rate (over 150,000) – 38.1%
To an individual without a background in accounting, this can seem complex and overwhelming but with the help of a professional accountant, the decision to form a limited company can be far more profitable in the long run. As sole traders only have to deal with Income Tax and NI they have far less paperwork to deal with and spend far less time calculating tax owed. However, the payoff for this is the higher amount of tax they end up paying overall and personal financial liability. It is worth remembering that the director is still ultimately responsible for filing accounts and tax returns, keeping company records and paying corporation tax. Failure to meet these responsibilities can result in fines, prosecution, and disqualification, but by appointing an experienced and reputable accountant these responsibilities will be dealt with and forming a limited company, with all its benefits, gives far more security and peace of mind.