Category Archives for Tax

What taxes do I pay as a Company Director?

Although it’s easy-peasy to create a limited company, it’s much harder to navigate the taxes associated with becoming a director. As a sole trader, it’s more straightforward and similar to being an employee. Once you’re a company director, you’re both a corporation/employer and an individual/employee. Yes, you get a dual identity. And you pay taxes through both identities.

In this post, I’ll explain the various taxes you pay as a company director and give a worked example, based on a typical setup. This is no substitute for seeking advice from an accountant, though. They can give you specific guidance on your situation. I won’t address taxes that apply only in certain niches, or cover people with income from multiple companies or employers.

Company Taxes

Corporation Tax

Once you’ve deducted your costs from your turnover, that leaves your profit. You’re then taxed at 19% on all your profits. Unlike personal income tax, there’s no tax-free threshold. Even if you make £100 in profit, you need to stump up £19 in corporation tax. You’re right, this is very unfair on new businesses.

You should complete a Corporation Tax return each year. Your tax payment is usually due nine months and one day after the end of your company’s financial year. This is different from personal tax returns, which are due in January.

National Insurance

If you pay a salary to yourself or anyone else and it’s above £8,632, you must pay Employer’s National Insurance (NI) at a rate of 13.8%. There’s an upper limit of £50,000, beyond which no NI is due. Accountants often recommend paying yourself a salary of £8,632 so you avoid NI as both an employer and an employee (see below).

NI payments are made through your monthly payroll system.

Value Added Tax

If you’re VAT registered, you need to charge VAT on sales and then pay it to HMRC every quarter. The good news is that the amount due is reduced by however much VAT you’ve spent on products and services for your business. Assuming you’re managing your cash flow properly and aren’t spending the VAT revenue between quarters, this tax shouldn’t make a dent in your finances.

Personal Taxes

Income Tax

No doubt you’re already familiar with income tax. As a company director, though, you often don’t pay it – depending on how you pay yourself. As I mentioned earlier, accountants often recommend that company directors pay themselves a salary of just £8,632. This falls below the personal tax allowance of £12,500 and the NI threshold.

Your salary counts as a cost to your business, so it’s not included in the profits on which Corporation Tax is applied.

National Insurance

As an employer, you pay NI only above £8,632 and it’s the same for employees.

So, a salary of £8,632 isn’t liable for either NI or income tax. As a director, you often pay yourself an additional income in dividends, which are taxed differently.

Dividend Tax

Now, this is where the sums get more complicated. Dividends are taxed at three different rates, depending on where they fall within the income tax bands. The first £2,000 of dividends are tax-free, then they’re taxed as follows:

Basic rate       

£12,501 to £50,000

7.5%

Higher rate

£50,001 to £150,000

32.5%

Additional rate

over £150,000

38.1%

Note, these rates are different from the rates applied to salaried income.

To calculate how much dividend tax you pay, follow these steps:

Dividend Tax - Step by Step

  1. Deduct your salary from your personal allowance (usually £12,500, but do check)
  2. Now you have your remaining personal allowance
  3. Deduct the figure from Step 2 from your dividends
  4. Next deduct £2,000 from your dividends – this is your tax-free allowance
  5. Now you have your taxable dividends
  6. Apply the appropriate tax rate from the table above.

It’s sensible, of course, to use a calculator, but it’s good to understand how it works so you can spot any discrepancies.

Dividend tax is paid through your personal self-assessment tax return, which is due in January.

There’s lots more on dividend tax on the HMRC website.

How do all the taxes work together?

Here’s an example to show you how it works.

Mel runs her own graphic design business. The turnover is £70,000 and her costs are £20,000. She pays herself a salary of £8,632 and dividends of £30,000. Her tax breaks down as follows:

Company profits = £50,000 (remember, her salary is included in the business costs)

Corporation tax = £9,500 (19% of £50,000)

Salary = £8,632, so no income tax or NI due

Dividends = £30,000

Mel still has some of her personal tax allowance left, as her salary was £8,632. The Personal Tax Allowance is £12,500, so another £3,868 of her dividends are also tax-free.

That takes us down to £28,132 that’s taxable.

Then we deduct the £2,000 dividend tax allowance, bringing the taxable figure to £24,132.

As this is within the basic rate tax band, it’s taxed at 7.5%.

Mel pays:

  • £9,500 in corporation tax
  • £1,809.90 in dividend tax
  • A total of £11,309.90

Key Points

  • As a company director, you pay tax as a corporation and an individual
  • Dividends are taxed differently from salaried income
  • Corporation tax is paid 9 months and 1 day after the end of your accounting period, not in January

Conclusion

As you can see, this is complex! This is why it’s a good idea to hire an accountant. You’re undoubtedly too busy to keep on top of an array of taxes that change each year. Make sure this cost is included in your pricing. Accounting software, such as Xero or Freeagent, should show how much tax your company needs to pay. You can use a dividend calculator to get an idea of your personal dividend tax liability.

Taxes aren’t desperately exciting, but you don’t really want the excitement of a nasty surprise.

Warning

This blog post does not constitute financial advice. Please seek advice from a qualified accountant.

Is it worth voluntarily registering for VAT?

I remember being delighted when VAT was increased to 20%. Not because I wanted to pay more for my chocolate biscuits,1 but because it was so much easier to calculate than 17.5%. Unfortunately, the standard rate is the simplest thing about VAT.

In this post, I’ll give you an overview of how VAT works, explain a few benefits of VAT registration, and also point out some of the downsides.

Before registering for VAT, you should definitely speak to your accountant. VAT registration brings many financial responsibilities, along with some stiff penalties for non-compliance.

What is VAT?

Value Added Tax, or VAT, is a tax applied to the sale of goods and services. Businesses and sole traders with an annual turnover above £85,000 are obliged to register and then charge their customers VAT, even if the customer isn’t VAT-registered themselves. A benefit of VAT registration is that you can then claim back the VAT on any goods and services you’ve purchased for your business. The amount you pay to HMRC each quarter is the difference between the VAT you’ve charged your customers and the VAT you’ve paid on your purchases.

For example, say your turnover for the first quarter is £30,000. Of this total, £5,000 is VAT. You’ve bought various bits of kit, supplies, and paid rent on your office, amounting to £3,000. The proportion of those costs that’s VAT is £500. So, to calculate your VAT bill, you deduct the VAT from your purchases from the VAT you charged on sales. In this case, you give HMRC £4,500.

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Watch Out!

Some of that VAT money will be sloshing around in your bank account for a few months before you need to pay it. Make sure you don’t spend it!

This hopefully seems quite simple so far. However, there are a few different VAT rates and schemes.

Different VAT Rates

You’ve probably noticed that VAT isn’t charged on everything and the rate sometimes varies. There are four rates:

  • Standard – that’s the 20% charged on most goods and services
  • Reduced – home energy, sanitary towels (controversially) are charged at 5%
  • Zero – applied to printed books, newspapers, children’s clothes, many foods
  • Exempt – health services provided by registered professionals, education provided by a school/university/college

If you’re a publisher, you wouldn’t charge VAT on paperbacks, but you’d need to charge it on ebooks (which are now on the standard rate).

Unless you’re selling zero-rated, exempt, or reduced products/services, you must charge 20% VAT once you’re VAT-registered. Remember, this is mandatory if your turnover exceeds £85,000.

This might sound unattractive if you have a good turnover but not much in the way of overheads. You get the faff of VAT without the benefits. Well, meet the flat-rate VAT scheme.

The Flat-Rate VAT Scheme

The flat-rate is a different system that benefits some eligible businesses. Under the flat-rate scheme (FRS), you still charge your customers VAT in the usual way, but you give only a percentage of it to HMRC. Sounds like a good wheeze, doesn’t it? The snag is that you can’t reclaim the VAT on your purchases unless you buy an eligible asset costing more than £2,000. The amount of VAT you pass on to HMRC depends on your business type. For instance, if you’re offering secretarial services, the rate is 13%; for accountants it’s 14.5%. Here’s what it looks like for Neil, a virtual assistant who invoices a total £45,000 over the year:

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How it Works

  • Total VAT charged to his clients @ 20% = £7,500
  • Total VAT payable to HMRC @ 13% = £5,176.99
  • Saving = £2,323.01
  • Neil pockets £2,323.01, but he can’t claim back the VAT on the software and stationery he buys. This works well for Neil, as his overheads are small and he works only for large clients who can claim back the VAT on his fees.

    For more information on the flat-rate scheme, take a look at HMRC’s webpages.

    How to Register and Pay VAT

    Before registering, speak to an accountant to make sure it’s the right move for you. Once you’re registered, it’s tricky to deregister.

    You can register for a VAT Online Account through the Government Gateway.

    If an accountant will be managing VAT for you (which is highly recommended), you’ll need to nominate them as an agent to act on your behalf.

    There are a few stages, so be patient!

    Not all VAT registrations are accepted. For instance, HMRC might decline your application if they decide you’re a tiny business and unlikely to generate much taxable revenue. Of course, the scheme exists to generate income for the government, not to help businesses. You can appeal by providing supporting evidence.

    Once you’re registered, you have to submit your quarterly VAT return online, using a Government-approved system. This is part of the Making Tax Digital initiative. Most of the major accounting software providers such as Xero and FreeAgent will have this covered. You can no longer submit paper-based forms.

    You have to submit a VAT return, even if there’s nothing to pay or reclaim. If you do owe money, you can pay by standing order, direct debit, bank transfer, or corporate credit card. The due date appears on your VAT return. Any refunds are transferred to your bank account (make sure you provide the details when registering), usually within 10 days of submitting your return.

    It could be worth voluntarily registering for VAT if:

    • You have a lot of overheads on which you’re paying VAT, e.g. office space, raw materials, software
    • Your clients are mainly large businesses (although please note: as they’re usually exempt-rated, universities and NHS are often unable to reclaim the VAT)
    • You’re approaching the threshold

    You can reclaim VAT on purchases made in the six months before registration, and also on some expenses within the previous four years.

    Voluntary VAT registration could be disadvantageous if:

    • Your business mainly serves individuals – e.g. you’re a hairdresser or a gardener, those customers will see a 20% hike in your charges. They might baulk at this increase and ditch you for somebody cheaper. Essentially, it can make you less competitive.
    • You’re managing all your accounts yourself. Hiring an accountant could cost more than you save.
    • You’re pants at managing cash flow. You’re probably receiving income monthly, but you need only stump up the VAT quarterly. This means there’s often some extra cash sloshing about in your account. Some people use this to help their cash flow; others dip into it and then have a stressful time paying the bill when it’s due. There are expensive penalties for non-/late payment.

    Key Points

    • You’re obliged to register for VAT once your turnover hits £85,000 per year.
    • You must charge 20% on all good and services, unless they’re zero-rated, reduced or exempt.
    • Your clients might be unable to claim back the VAT, making you more expensive.
    • VAT registration brings many responsibilities, so make an informed decision.
    • You should speak to your accountant before taking action to ensure you understand all the implications.
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    Warning

    This is absolutely not financial advice. Please speak to your accountant before deciding to become VAT-registered.

    1. plain biscuits are zero-rated []

    How do I pay National Insurance as a Sole Trader?

    It’s not often I see fear in a client’s eyes. This happened recently, though, when I casually mentioned National Insurance. The chap concerned had just gone freelance, after carefully planning his transition from employee to free spirit. Somehow, in all the excitement, a crucial element had escaped his notice. Understandably so, I think. After all, nobody who creates a business has a burning desire to understand the National Insurance (NI) system. However, a basic knowledge of how NI works, and what you need to pay and when, will help you now and when you reach state retirement age.

    In this post, I’ll explain this unnecessarily complicated tax and also share some tips on paying it if you’re self-employed.

    What is National Insurance?

    When it was first introduced in 1911, National Insurance was indeed an insurance scheme. Contributors were rewarded with payouts if unable to work or once they’d reached the state retirement age (70, at the time). The method of recording contributions was through stamps affixed to a card, which is why you’ll sometimes hear people refer to paying your stamp.

    It’s since become far more sophisticated and there are now six types of National Insurance contribution. Thankfully, as a sole trader, you need only concern yourself with two of them:

    Class 2 National Insurance

    This is a fixed weekly amount of £3, regardless of your income. You’re not obliged to make Class 2 contributions unless your profits1 exceed £6,365. Nevertheless, it could be worth making voluntary Class 2 contributions. Why on earth would you pay more tax than necessary? Well, because this affects your state pension entitlement. To qualify for the full state pension, you need to have made 35 years’ NI contributions. Any gaps reduce the amount you’ll receive. So, paying £156 per year now could boost your income significantly in the future. Additionally, you need to have made Class 2 contributions to be eligible for other benefits, such as Employment and Support Allowance (the only sick pay you’re entitled to as a sole trader).

    Class 4 National Insurance

    These contributions behave more like a tax. Class 4 contributions are paid as a portion of your profits, so what’s left over once you’ve deducted any allowable expenses from your turnover. You’re liable for Class 4 NI payments if your profits exceed £8,632. You’ll pay 9% on profits from £8,632-£50,000, and 2% on profits above that amount. These contributions aren’t linked with state benefits.

    To recap:

    • Class 2 if your profits are £6,365 or more a year and
    • Class 4 if your profits are £8,632 or more a year
    • You pay £3 per week (£156 per year) for Class 2 and
    • 9% on profits from £8,632 – £50,000 for Class 4. It drops to 2% on profits above £50,000.

    How do I pay National Insurance?

    Fortunately, this part is straightforward – and you no longer have to collect stamps on a card. Both Class 2 and Class 4 contributions are paid along with income tax through your self-assessment tax return. As you probably know, this is due by 31st January – both the return itself, and your payment.

    You stop paying any NI contributions once you reach state retirement age, although you’re still liable for income tax.

    How can I calculate my National Insurance liability?

    The best way to deal with tax returns is to prepare well in advance. The tax year ends on 5th April, so you have almost 10 months to do some calculations and start saving, if you haven’t already put some money aside. StepChange has created a useful online calculator to give you clarity on what you’ll need to pay. For example, if your turnover is £30,000 and your business costs are £2,000, you’d pay:

    • Class 2 – £156
    • Class 4 – £1743.12
    • Income tax – £3099.96

    That’s a total of £4999.08.

    Screenshot of sole trader income calculator

    As a sole trader, your income probably fluctuates. It’s worth using this calculator each month to ensure that you’re not taking too much money out of the business. Nobody enjoys saving for tax, but a monthly sacrifice is better than a big bill just after Christmas. Remember, Class 2 contributions are fixed at £3 per week, so it’s easy-peasy to budget for this amount. Think of it as an annual subscription of £156 that you pay every January.

    Conclusion

    The Government has promised to overhaul National Insurance and a review is currently in progress. Given everything else that’s going on, this is unlikely to be a priority.  In the meantime, using the calculator and setting aside your £156 should keep you on track. And you might even get a state pension when you’re 95.

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    Key Points

    • check
      You pay Class 2 and Class 4 NI contributions through your self-assessment tax return.
    • check
      Class 2 NI contributions help you qualify for the state pension and other benefits, such as Employment & Support Allowance. It could be worth paying these contributions voluntarily, even if you haven’t reached the profits threshold of £6,365. The annual amount is £156.
    • Calculating your NI and tax liability each month can help manage your cash flow and avoid surprise bills in January.
    1. turnover minus allowable expenses []