Every new business needs some sort of startup fund. For some businesses, the costs are small, for example your local youth club’s carwash enterprise needs are simple; there are sponges, soap and a hose pipe. A professional valet’s costs would be much higher, with the right shampoos, pressure hoses, vacuums, alloy wheel treatments and any other number of high end cleaning products come at a much higher price.
To the casual observer, as long as a business is bringing in more money than they’re having to pay out, then the business is doing “OK”. The problem for many companies, particularly small Limited Companies and startups, is that this doesn’t tell the full story. Overheads such as office space, energy and staff salaries are business critical as without paying these, the business can’t function. Lots of small companies find that invoices to their equally small clients can be paid several weeks or even a few months after the invoice due date, meaning that expenditure carries on and income is stunted.
There used to be a joke about getting a straight answer out of certain tradespeople; they’d suck air over their teeth and say “Well it depends!” and by the time you got round to pinning them down and asking exactly how much it would cost the answer would be something like “Ninety-five pounds… plus VAT”.
VAT has been with us in one way or another for over 75 years. In 1940, “Purchase Tax” was introduced on ‘luxurious’ items at the confusing level of 331/3% and rose to 100% a few years later. Purchase Tax wasn’t paid by customers when they bought items, but by the manufacturers and distributors. In 1973, when the UK joined the EU, Purchase Tax was replaced by Value Added Tax, which was paid by customers every time they bought certain items as opposed to being charged to businesses.
It doesn’t really help to say what VAT is, however. Other countries call it General Sales Tax and all it means is that a percentage of tax is added onto the top of many goods and services. If you call out a plumber who charges £100 for his time, once UK VAT at 20% is taken into account, you’d pay him £120 and the plumber would pass the extra £20 onto HMRC.
If you’re working as a business in the UK, once you start to earn £85,000 a year, you must register for VAT – if you’re involved in distance selling into the UK, the threshold is £70,000. This means that all of your sales, whether it’s goods or services must have an extra 20% added to them that you pay to HMRC. VAT also applies to hiring or loaning goods, selling business assets and commission. Many businesses choose to register for VAT before they hit the £85,000 threshold but it’s important to note that if you do register, you must charge VAT on all applicable sales. If you’re not registered, you cannot charge VAT on your invoices.
Most goods and services in the UK need to charge 20% VAT, but there are reduced rates of 5% for home gas and electricity supply or child car seats. More essential items are either exempt or have a zero-rate VAT cost, such as motorcycle helmets, insurance or children’s clothing and shoes. Unless you’re involved in selling these particular exempt items, once you register for VAT, you’ll need to add 20% to all your invoices.
If you’re a VAT registered business, then you (or your accountant) must report a VAT return to HMRC every three months. If you’re a business that pays VAT, then if you’ve charged more VAT to your customers than you’ve paid to other businesses, then you hand over the difference. Rather nicely, if you’ve paid more VAT to others than you’ve taken yourself, then you get to claim the difference back from The Taxman!
VAT is a complicated bit of tax law, but the principle is quite simple, everyone who buys certain goods and services must pay 20% tax over the cost of their item and it’s up to the business that sells it to pass on that tax to HMRC. There’s also Flat Rate VAT, which we’ll cover in another blog – so make sure to come back soon!
Photo credit: P T Money
When people decide to take the plunge and start working for themselves, there are always a lot of questions for the accountant! If it’s the first time working for yourself, there’s usually an element of uncertainty about how to make it all work financially; how do you get paid? How do you keep the taxman happy? How do you go about expenses and costs?
This is usually when the conversation about setting up a limited company arises, but it can leave people a little confused – what is a limited company and why would you need to be one?
Many people still think of being Self-Employed as it was in the old days, such as your gardener, window-cleaner or even driving instructor – one person does the work and filled out a tax return at the end of the year. This is known as Sole Trader and is exactly as it sounds, one person working independently.
There are a number of potential drawbacks to being a sole trader and one of the biggest is liability. If your business suddenly drops off, then as only you are the business, any debts are your personal responsibility. Imagine a driving instructor; if lessons suddenly dry up and the car payments stop, then any assets – including your house – could be used to recover payment. If you face litigation or somebody sues, then the same applies and you’re personally liable.
Setting up a Limited Company overcomes these issues – your liability is limited to being a shareholder. Essentially, you create the company and become the company director as well as an employee. If the company is sued, you don’t risk company debts being recovered from you personally – the only time this would apply would be for illegal or fraudulent activity.
Limited companies also make getting paid and paying tax easier. By allowing your accountant to take care of payroll, you are paid PAYE – Pay As You Earn. Instead of tracking how much money you take in and pay out over the year, you give yourself a monthly salary, just as you would if you worked for somebody else. If you earn enough to pay tax, then you can pay it direct to HMRC instead of waiting for the end of the year. The same works for National Insurance.
The benefit of being a limited company that interests most people, however, is the ability to take Director’s Dividends. If your company does well, then as a director and shareholder you get to take some or all of the previous year’s profits – and best of all, some of it is tax-free! For this year, the good ol’ tax man will let you have the first £5,000 without taking any tax! If your business does really well, then the good news is that anything over £5,000 has a tax rate of 7.5% (up to the higher rate taxpayer threshold), which is a lot lower than the normal Income Tax rate of 20%. It’s worth bearing in mind that dividends can only be paid on company profits, which have already had the Corporation Tax paid on them.
Being a limited company allows you to concentrate on your day-to-day work, rather than a constant niggle in the back of your mind about the taxman or keeping track of how much money you’ve taken so far this year. Although it might feel like a big step to set up an entire company, there are many benefits, from protecting yourself legally right through to being able to earn more money!
Are you a limited company and extract most the money via dividends? With effect from the 6th April 2016 the tax rules change on dividends. The first £5k will be tax free, then basic rate tax payers will be charged 7.5%, higher rate tax payers at 32.5% and additional higher rate payers at 38.1% – contact us for more information on how this will affect you