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A Guide to Taxable Income in the UK

Author Melissa YeoMelissa Yeo

7 min read
Tax Advice

Being the boss of your own company means you get the flexibility to decide your own schedule, but when it comes to tax season, things might get a little confusing. No worries though, we're here to guide you through the process so you can stay compliant with the law.

A Guide to Taxable Income in the UK

When tax season in the UK arrives, along with “taxable income” and other tricky terms, it’s understandable that you can find it all a little confusing.

This guide will help you navigate the process so you can stay compliant with UK tax laws and keep your business game strong.

We’ll unpack the most important aspects of taxable income for UK business owners. But if you’re tired of paperwork and want to offload the bookkeeping for your business ahead of tax season, we can help with that right now.

How Much Can I Earn Before Tax Kicks In?

The first and most influential factor that determines how much you get taxed in the UK is your income bracket. But first, the good news! A personal allowance of tax-free income is something most people will be entitled to in the UK.

The amount of these nontaxable earnings is designated by the UK’s governmental bodies and may adjust year-on-year. For example, you’d be entitled to £12,570 in the 2022/23 tax year.

How Much Do I Have to Earn To Pay Tax?

Anything over your personal allowance is considered taxable income. The exact rate is based on your business income tax band:

  • 20% Basic Rate: Standardised at a flat rate of 20% for anyone earning an income that doesn’t exceed £50,270.
  • 40% Higher Rate: A taxable rate of 40% applies to any income between £50,271 - £150,000
  • 45% Additional Rate: This rate applies to any earnings over £150,000.

Which Part of My Business Income Is Taxable?

The taxable portion of your business income is also known as business tax or corporation tax. It applies to profits made by a limited company after deducting salaries and other business expenses, but before dividends are withdrawn. Business income tax needs to be paid on profits earned from:

  1. Doing business or ‘trading profits’

Elizabeth runs a fashion apparel store and earned £520,000 from her operations in 2020. This does not include any financing-related expenses or income, or any losses or gains on the sale of assets. Elizabeth will have to pay Corporation Tax on her trading profits, which is £520,000.

  1. Company investments

Stephanie runs an investment company, with its core business focused on the buying and selling of investments with the aim of making profits. These investments are the company's trading stocks and the profits from the sale of these investments is taxable.

  1. Chargeable gains - surplus from selling any company assets for more than the cost price

In a sale of equity interests, Isabelle managed to find a buyer who has agreed to purchase a portion of the outstanding equity interests in an entity from her technology company and made a profit from this transaction. In this circumstance, her profit will be taxed.

How and When Do I Pay Business Tax?

Check  you're registered

Within 3 months of setting up your UK company, you have to register for business tax. This is a fairly simple online process but if you need a hand, we’re here to help you out!

File a Company Tax Return

HM Revenue and Customs (HMRC) will inform you that you need to file a Company Tax Return. Returns have to be filed, whether or not you make a loss or do not owe Corporation Tax. You’ll need to submit an online form CT600 to HMRC annually which consists of your company’s finances.

Know your tax deadlines

Business tax is payable within 9 months and one day after the end of your company’s accounting period (a date also known as your company’s financial year end). You’ve got the flexibility to pay any time during this period but doing it as early as possible helps avoid oversight and the risk of fines.

Just incorporated your company?

You may have two Corporation Tax accounting periods since your accounting period for corporation tax purposes cannot be longer than 12 months. To pay business tax, you will have to log in to your HMRC online account and select your preferred payment method.

What Income Is Tax-Free?

The UK’s state benefits system provides individual support, which is on a discretionary basis and only at times of need as deemed by the state. While some are taxable, tax credits and universal credit are not considered taxable income.

Income that is tax-free in the UK will usually include:

  • Tax-free savings and other investment income
  • Tax-free non-savings income
  • Tax-free state benefits

Remember:

Tax-free income encompasses funds paid to you, without the tax amount having been taken off the base amount you’ve earned. Keep in mind that this doesn’t mean that it’s tax-free or exempt from being taxable (it may be up to you to pay the tax).

Business Tax vs Income Tax: What’s the Difference?

Business tax applies to profits made by a limited company after deducting salaries and other expenses, before the withdrawal of dividends.

Income tax applies to certain income you receive in a personal capacity, like a salary, rental income or dividends.

Income made from selling assets such as share disposals or a property which is not your primary residence is subject to capital gains tax. If you are the director of a limited company and draw a salary from it, income tax is made via your company’s pay as you earn (PAYE) scheme.

A sole trader’s income tax is based on the profit made from your business, which is taken into consideration within your self-assessment tax return.

What Is Unearned Income?

Business income that’s considered “unearned” can still be subject to being taxed. In the UK, this applies to rent, dividends, interest and capital gains which we touched on earlier. Determining your total taxable income also takes into consideration any disability or unemployment government benefits, casino or lotto winnings or forgiven loans.

How Do I Calculate Taxable Income for My Business?

Taxable profits are usually determined by the profits reflected in your business accounts after they’ve been adjusted in compliance with UK tax rules.

Your total income consists of all business income that falls within the accounting period. Also known as turnover or sales, this should already be a feature in your everyday business records, making it a simple calculation in tax season.

There are two ways to prepare accounts:

Cash basis accounting

The process of recording your revenue or expenses when you pay or receive money. Businesses that employ this method recognise revenue and expenses only when the money arrives or leaves their business bank account.

These include government agencies, non-profit organisations, community associations and small service businesses that don’t sell on credit and pay bills at the time they are incurred.

If you record earnings and expenses in this way, your total income will be the amount of sales income made in the accounting period. For example, if work was carried out in 2020/2021 but paid for in 2021/2022, income will only be recorded and realised in 2021/22.

Accrual basis accounting

The process of recording your revenue or expenses when you get billed or send an invoice. Businesses that make use of this method acknowledge revenue as soon as the customer is invoiced. When the business receives a bill, this is acknowledged as an expense even if the payment will not be incurred for another month.

For instance, if you issue a customer an invoice on 14 October 2021 and draw up accounts to 31 December 2021, this invoice would be included in the tax year 2020/2021, whether or not the customer has made payment.

What is my basis period?

Your basis period is the assessed time frame you will be charged tax in that particular year. Every tax year is a 12-month period that usually starts in April and since accounts are generally prepared to the same accounting date every year, you pick a date that works for you!

The easiest date would be in accordance with the tax year, which is 5 April. If you prefer to follow the calendar year and prepare accounts to 31 December, then your accounting period is the 12-month period before 31 December.

Every year, Stephanie prepares accounts up till 30 April. Her basis period for 2022/23 is the year that will end on 30 April 2022. This means the tax Stephanie pays for the assessed 2022/23 tax year is the tax on her taxable profits for the basis period of 1 May 2022 – 30 April 2023.

Taxable Income vs. Nontaxable Income in the UK

In the UK, non-taxable income is considered as any earnings received through work done for a charitable organisation or religious body which is returned to that institution in due time.

An employee achievement award is also considered nontaxable income along with life insurance benefits received as a beneficiary. Remember, all regulatory conditions have to be adhered to and those earnings could be subject to a different type of tax. For example, that life insurance benefit may not be considered taxable income but it’s likely to be subject to estate tax.

How To Reduce Taxable Income for Small Business

Capital Allowances

Some expenses - like things you require for your company - can be considered capital expenditure instead of a trading expense or revenue.

If you use the accrual basis accounting, you aren’t allowed to subtract capital expenditure from trading profits but you may be allowed to claim capital allowances for this expense. Once you have made your calculations, capital allowances are considered a trading expense and can be subtracted from your profits.

Elizabeth has purchased new photography equipment for her studio in February 2021. The equipment cost £5,000 and she proceeds to prepare her accounts using the accrual basis accounting method. Under the annual investment allowance scheme, her equipment is eligible for 100% capital allowances. As such, Elizabeth's taxable profits will be:

Profits £49,500Capital allowances
Capital allowances £5,000
Taxable profits £44,500

VAT exclusion

If your company is registered for Value Added Tax (VAT), the amount for trading income will be your sales exclusive of VAT. However, if your company is on the Flat Rate Scheme, then your trading income would be your sales net of flat rate VAT.

Taxes Don’t Need To Be Taxing

Tip

Our Osome team can take over your paperwork, cross-check data and submit annual reports while your dedicated Chartered Accountant ensures your tax is paid smartly and is available for any queries along the way.

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