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A Guide to Business Income Tax in the UK

A Guide to Business Income Tax in the UK

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.

By the way if you are tired of paperwork and need to offload your bookkeeping for your business while preparing for tax season, we can help you with that. Otherwise read on.

Which Part of My Business Income Is Taxable?

The taxable portion of your business income is also known as business tax, or Corporation Tax. Business tax is applicable to profits made by a limited company after deducting salaries and other business expenses, but before the dividends are withdrawn.

You will have to pay Corporation Tax on the profits you have earned from:

  1. Doing business (‘trading profits’ – the money you make from carrying out your trade),

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. Your company’s investment

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. And surplus from selling assets for more than their cost price (‘chargeable gains’ – your company assets include company shares, equipment and machinery, as well as land and property).

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 that you’ve registered for business tax

Within three months of setting up your company, you should already have registered for business tax. This is a fairly simple process and shouldn’t take you longer than 10 minutes to complete online, otherwise we can help you with this.

Then, file a Company Tax Return

HM Revenue and Customs (HMRC) will inform you that you need to file a Company Tax Return. Regardless of whether you make a loss or do not owe Corporation Tax, you must still file a return.

You will have to submit an online form CT600 to HMRC annually. This form should consist of your company’s information including income, minus any tax allowances and expenses.

Take note of the deadline for paying tax

The business tax you owe must be made 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). During this period, you have the flexibility to make payment anytime, and we recommend doing so as early as possible to avoid oversight and possibly incurring fines.

If you've 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.

For instance, if you start your company in January, you will have 2 corporation tax returns, one for the period from January to January, and the 2nd one from January to March.

To pay business tax, you will have to login to your HMRC online account and select your preferred payment method.

What are the Tax Rates for Tax Year 2021/22?

The 2021/22 tax year begins on 6th April 2021 and the Corporation Tax payable on company profits remains at 19%. However, at the March 2021 budget, the Chancellor announced plans for a rise of Corporation Tax headline rate to 25%, with effect from April 2023.

From then on, there will be an introduction of a new small profits rate of 19% for businesses with profits of not more than £50,000 with a tapered increase to the rate as profits grow. Companies with profits of more than £250,000 will be required to pay the 25% main rate from April 2023.

The Difference Between Business Tax vs Income Tax

Business tax is applicable to profits made by a limited company after deducting salaries and other business expenses, but before the dividends are withdrawn.On the other hand, income tax is made on certain income you receive in your personal capacity, such as salary, rental income and dividends.

For any income made from the sale of assets, such as share disposals or if you sell a property which is not your primary residence, you are not required to pay income tax, but this would be taxed under Capital Gains.

If you are the director of a limited company and receive salary from it, income tax is made via your company’s PAYE (pay as you earn) scheme. The PAYE scheme is a HM Revenue & Customs (HMRC) system used to gather Income Tax and National Insurance from employment, where the employer deducts Income Tax and National Insurance contributions from employees’ wages and sends it to HMRC.

For sole traders, your income tax will be based on the profit made from your business, which is taken into consideration within your self-assessment tax return.

How Do I Calculate Taxable Income for My Business?

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

Your total income should consist of all your business income that falls within the accounting period. Your business income is also known as turnover or sales, which should already be a huge part of your everyday business records, making this calculation fairly simple when it comes to tax season.

When it comes to preparing accounts, there are two ways to do so -- either through cash basis accounting, or accrual basis accounting:

Cash basis accounting

Cash basis accounting is 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 since they do not sell on credit and pay bills when they are incurred.

If you record your earnings and expenses on a cash basis accounting, then your total income will be the amount of sales income made in the accounting period. For example if the work was carried out in 2019/2020, but the work is paid for in 2020/2021, the income will only be recorded and realised in 2020/21

Accrual basis accounting

Accrual basis accounting is 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 2020 and draw up accounts to 31 December 2020, this invoice would be included in the tax year 2019/20, regardless of whether the customer has made payment or not.

What is my basis period?

Your basis period is the assessed time frame you will be charged tax in that particular year. Typically, the basis period is the 12-month accounting period that ends within the assessed tax year.

Every tax year is a 12-month period that usually starts in April. For instance, the 2021/22 tax year starts from 6 April 2021 to 5 April 2022.  

Since accounts are usually prepared to the same accounting date every year, you can pick a date that works best for you. This can be any day in the year, but the easiest date would be in accordance to the tax year, which is 5 April. If you prefer to follow the calendar year and prepare your accounts to 31 December every year, then your accounting period would be the 12-month period before 31 December.

Every year, Stephanie prepares accounts up till 30 April. Her basis period for 2021/22 is the year that will end on 30 April 2021. This means that the tax Stephanie will pay for the assessed 2021/22 tax year is the tax on her taxable profits for the basis period of 1 May 2020 – 30 April 2021.

How to Reduce Taxable Income for Small Business

Capital Allowances

Some expenses can be considered capital expenditure instead of a trading expense or revenue. If it is something you require for your company, this will typically be treated as a capital expense and not a revenue expense.

If you use the accrual basis accounting, do note that you are not allowed to subtract the capital expenditure from your trading profits. However, 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), remember that 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.

Need Extra Help With Your Taxable Business Income?

Tip

Taxes doesn’t have to be taxing. Leave it to us at Osome - we take over your paperwork, cross check data, and submit annual reports neatly. You will also have a dedicated Chartered Accountant to help pay your tax smartly and respond swiftly when you have queries.

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