Every year, the Chancellor of the Exchequer spells out the vision for the future and while most of the headlines are taken up by announcements on extra taxes for a pint of beer, a glass of wine or a tank of petrol, the announcements go much further than that. Anything and everything from Income Tax, pensions, National Insurance and VAT are spelled out for the coming years – things that actually directly affect the pay-packet of everyone in the country.
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.
Just about everybody knows that they now need a workplace pension, as well as the one that is currently paid out by the Government at retirement age. It’s been quite a successful campaign for the government, as the big purple monster in the ads has made everybody aware that if they’re employed, then they need to pay into a workplace pension and their employer must too.
We’d all love a job where our expenses were paid back to us! Working in a job where we could get all our travel, petrol or even food paid back to us would be a dream! – but it’s unlikely to happen for most of us. Most people are stuck paying for their travel to the office and all the other things we need to pay for, simply because it’s part of the cost of being employed; we need to get to and from work and we need to eat.
If you’ve not read out initial blog on charging Value Added Tax in the UK, it’s probably best to read that first – you can do so here
So, now you’re up to speed on what VAT is supposed to do, how it works and that there are three different rates of VAT. Just to make things nice and complicated, the UK Government decided to shake up the system back in 2002 by introducing Flat Rate VAT.
As we know, the idea of VAT is that a business will charge it to all their customers, but pay it to all their suppliers. If you’ve charged more VAT than you’ve taken, then you pay the difference to HMRC. If you pay more than you take, then you can claim the VAT back. This obviously takes a lot of accounting and administration to add up all the figures and see where the final balance comes out, so the Government introduced Flat Rate VAT to simplify the system.
The idea of the Flat Rate system was that businesses could pay a certain percentage of all the VAT they took to HMRC and keep the rest. Not only did it save time and a lot of work, but it would still bring HMRC about the same amount of money and businesses would like it because they got to keep some of the VAT charged to customers.
The rates for flat rate VAT vary dependent on what type of business you have, but if you have a company that brings in £12,000 per month, £2,000 of that would be VAT charged at 20% – £10,000 + 20% VAT = £12,000. If your flat rate VAT was 10%, then you’d only have to hand over £1,200 of your VAT take each month to The Taxman, meaning businesses got a cash boost of around £9,600 per year without the Government losing out.
All this changed, however, last November. The system was updated, as many small businesses run as service providers, meaning that large amounts of their business is digital and they don’t have to buy raw materials. This means that businesses like design agencies or IT consultancies have limited costs, as they do a lot of their business online or digitally. The government changed the rules so that “limited cost traders” that don’t have to spend a lot on raw materials and therefore don’t pay a lot of VAT wouldn’t be in a position to keep significant amounts of VAT money, as listed in the example above.
The new rules that were brought in earlier in the year mean that limited cost traders now have a flat rate of 16.5% to pay. If we look at the example earlier, a company that takes £12,000 a month including VAT would now have to hand £1,980 of their monthly VAT take over to HMRC, meaning the company would benefit by £240 per year as opposed to £9,600.
Many small businesses that are classed as limited cost traders are concerned as they still have to pay VAT to other businesses, such as IT firms, marketing agencies, accountants and consultants, as these service providers don’t count towards the VAT offset. If you’re required to pay VAT, then you need to look at the amount you spend to other businesses each month and how much you bring in as VAT to see if it’s worth working under the Flat Rate Scheme or if you could limit the amount that you have to pay to HMRC by going back to the more complicated, two stage system.
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
Corporation Tax – or Corp Tax – is one of those things that makes the headlines every so often and it’s now back in the news! A few years ago, reports came out that international companies such as Google, Facebook and Starbucks weren’t paying enough UK Corp Tax. A few years after that, Corp Tax was reduced, but there’s a lot of discussion in the run up to the election whether it should be raised to provide future Government spending money.
That doesn’t really answer the question; what exactly is Corporation Tax?
Put simply, the Government takes a percentage of all companies’ profits. Once a company has paid their salaries, rent, suppliers and everything else, what’s left over is profit and (currently) companies give 19% of it to HMRC at the end of the year.
The news on big companies not paying UK Corp Tax was because money that was made in the UK was legally moved to other European headquarters, where Corporation Tax was lower. Many felt that money made in the UK should be taxed in the UK and after the headlines, many companies started paying more UK Corp Tax.
So how does it affect small business owners?
Many small businesses run as Limited Companies, which only employ one or two people. If you are the only employee of your limited company, then it can make a difference to how much tax you pay, and whether it’s Corp Tax or personal Income Tax.
Imagine your one-person limited company took £20,000 last year. If you have no other expenses and pay yourself all £20,000 in salary, there’d be no profits, so wouldn’t need to pay Corp Tax. You would however, need to pay personal Income Tax. You can pay yourself less so your company has profits, but then you’d need to pay Corp Tax. The difference is that Income Tax is 20%, but currently Corp Tax is only 19%, so for a one-person limited company, it’s possible to save some money by paying Corp Tax over Income Tax. Obviously if you have more expenses, you pay less Corp Tax – so every salary and supplier you have to pay reduces the amount of profit you have.
Once the Corp Tax is paid, then the profits left can be paid to the company directors as dividends – and everyone has a personal allowance for director dividends that they can receive tax-free!
Corporation Tax is meant to be the fairest way of collecting taxes on companies as it only affects their profits – so the more they make, they more they can afford to pay. For small one or two-person businesses, the idea of paying more Corp Tax can be worrying as profits tend to be much smaller and margins tighter. Paying more in Corp Tax reduces the amount left over in post-tax profits that can be paid to the company directors in dividends, which can leave some directors earning less. If the suggested Corporation Tax rate rises to 26%, then company directors may find it more cost effective to pay their directors more in salary.
What may be comforting to know is that the current rate of 19% is the lowest flat rate the UK has ever had; when Corporation Tax was introduced it was 40% – and has been as high as 52%! Whether it goes up or down, there are no plans to put it back to as high as it was back in the old days!
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!
What does the Budget mean for you
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