Small business tax is something that all start-ups have to worry about. Whether you are a sole trader, limited company, or partnership you need to think about the taxes required for your legal enterprise. What are the laws concerning small business tax, and what choices are involved. Keep in mind that MTD is being implemented for all businesses, and this information will apply there. For more information on MTD, read here.

Which businesses don’t pay tax

Sole traders and partnerships have the same tax requirements as an individual when it comes to the lower limit. You do not have to pay taxes if your annual income is below the threshold of £12,570. Below this, anything earned is part of your personal allowance, as set by HMRC. 

This differs for limited companies because they operate as an independent entity, not an individual. Limited companies must pay 19% tax on all profits made, regardless of how small. Do keep in mind that any business expenses can be taken away from the profit. An example of this would be if £100,000 total is earned, but £30,000 was spent on training, only £70,000 would be taxed.

What taxes do businesses pay

Income tax

Income tax refers to the personal income that an individual can be taxed on. For sole traders and partnerships, this references their entire income. For limited companies, it’s the wage the owner pays themself out of their business accounts. The rate at which you are taxed varies greatly between different bands:

• Up to £12,570 a year is taxed at a 0% rate. (personal allowance)
• £12,571 to £50,270 a year is taxed at a 20% rate. (basic rate)
• Those who earn £50,271 to £150,000 a year get taxed at a 40% rate. (higher rate)
• Additionally, anything over £150,000 a year has a 45% tax rate. (additional rate)

Furthermore, any earnings surpassing £125,140 have no personal allowance. This cannot be avoided by earning £125,139, as a personal allowance is lowered by £1 for every £2 earned past £100,000.

Corporate tax

Sole traders and partnerships do not pay corporate tax, but limited companies do. Corporate tax refers to the aforementioned 19% tax on all earnings that are made by the business entity. You must either report that you have nothing to pay or pay the tax by the deadline. Said deadline is often 9 months and one day after the accounting period ends.

If your company ceases to trade or do business, you can report it as dormant. This means that unless requested to by HMRC, you do not have to file a company tax return, or pay corporation tax.

National insurance

National insurance is paid by the director of limited companies, which is how their NIC (national insurance contribution) is handled. Sole traders, and therefore partnerships, are handled differently. 

Sole traders pay class 2 and class 4 national insurance depending on their profits. They pay this through their self-assessment most often. In the cases where sole traders also have an employer besides their self-employment, they should pay class 1 for their employment, whilst paying 2 and 4 as sole traders.

You can choose to voluntarily pay national insurance to avoid gaps in your national insurance record. Often, this is opted for by those with seasonal work or who have a gap in employment.

Value Added Tax (VAT)

VAT is incredibly complex and has a variety of differences depending on where and how you sell services/products. For a more in-depth read, you can find our blog on VAT here.

Businesses that do not make at least £85,000 a year don’t have to pay VAT. If you buy or sell from other businesses frequently, you may want to opt into VAT. This is because it allows you to claim on purchases made from other companies that are VAT registered. It also makes the business seem far larger, and makes your prices competitive since other businesses can also claim back VAT on purchases made with you. 

Business rates

Business rates are charged on most non-domestic properties. Examples of such include:

• Shops
• Pubs
• Warehouse
• Offices
• Factories

A property’s business rate is calculated based with its open market rental value on April 1st, 2015. Properties are often revaluated on a 5-year basis, however, covid-19 has slowed the process for the most recent reevaluation.

You can estimate how much your business rate would be. To do this, take the rateable value of the property and apply the multiplier which you would ordinarily take. To decide the multiplier, simply look at the rateable value, £51,000 or below is small whilst above is standard. The standard multiplier as of 2021-22 is 51.2 pence, and the small business multiplayer for the same period is 49.9 pence.

Example: A property valued at £10,000 would be in the small business multiplier bracket. You would multiply the value by the small business multiplier, to get the taxable value. £10,000*£0.499 = £4,990 (the taxable value).

Business rates relief

Small businesses have the opportunity to avoid this tax, possibly altogether. If a property has a rateable value of less than £12,000 then the business pays no business rates. From £12,000 to £15,000 businesses pay a percentage of the tax. This is calculated as whatever percentage of £3000 above £12,000 that the value is. For example, a property of £13,500 would pay 50%, as 13500-12000 = 1500, 50% of £3000. 

This mainly applies if the business only has one property. You can only claim this on more than one if:

• The other properties have a rateable value of less than £2,900
• The total rateable value of all properties is less than £20,000 or £28,000 in London

Capital Gains Tax

Capital gains are when an asset of some kind is sold or disposed of for a profit, the capital gain being the profit. Capital gains is taxed once your total profit from this medium goes above the tax-free allowance of £12,300 (£6,150 for trusts).

Once you surpass the tax-free allowance, tax is paid on whatever you earn above this. As a business or trust, you pay 28% tax if the asset is a residential property and 20% tax on other assets. This lowers to 10% for sole traders that qualify for Business Asset Disposal Relief.

Business Asset Disposal Relief

This is when businesses sell parts of or the entirety of themself and meet certain criteria. If they do meet the criteria to fit into one of the abiding categories, they qualify for a reduction on taxes for their capital gains, this reduction is set to 10%. 

To qualify when selling parts of or the entirety of a business you must:

• Be a sole trader or a business partner
• Have owned the business for at least 2 years prior

If you sell shares or securities, to qualify:

• Being an employee or officeholder of the company is mandatory
• Trading must be the company’s main activity

Furthermore, if the shares are from an Enterprise Management Incentive (EMI), you must have been given the opportunity to buy them 2 or more years before selling them, and they must have been acquired after the 5th of April 2013.

If the shares are not from an EMI, you must have 5% shares and voting rights in the company for at least 2 years. You should also be entitled to 5% of the profits for distribution and assets on winding up, as well as disposal proceeds if the company happens to be sold. 

In the case that the shares you hold fall below 5% due to the company issuing more shares, you still have an opportunity to get business asset disposal relief. To do this, You must elect to be treated as if you had sold the shares immediately before the new ones were issued.

Things of note

Sole traders and partnerships are very similar in their requirements, the main difference being they pay taxes on their share of the profits. Clearly defining these profits in tax returns and accounting periods is vital to ensure the correct tax is paid. 

Limited companies are their own entity that must pay tax, whilst the owner pays tax as if they were an employee under it.