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Archives for February 2019

Corporation Tax – Part 1

Corporation Tax Adjustments

Clients often ask about why their corporation tax liability is not exactly the 19% of their profit. This is due to the adjustments that are made before calculating the liability for corporation tax. By these adjustments, we mean the addition of disallowable expenses back to profits as well as the deduction of capital allowances or losses from the profits.

Following is the list of some of the common disallowable expenses that are usually added back to profits for corporation tax purposes.

Company Setup or Incorporation Expenses

Company set up or incorporation costs are disallowable expenses. It is acceptable to include these costs as part of profit and loss account, however, these are added back to profits before calculating the corporation tax liability.

Depreciation Expenses

It is a standard accounting practice to capitalise the company assets which can be used for more than a year. This is to say that cost of these assets will not be expensed but rather recorded as a balance sheet item under Assets. It is then estimated that how much this asset would depreciate over its useful life. This estimation is expensed through the profit and loss account as depreciation expenses. However, for corporation tax purposes, this amount is added back to profits.

For example, fixtures bought by the company with the initial cost of £5,000 and 5 years of useful life will be depreciated by £1,000 each year. This £1000 will be recorded as depreciation expenses under the profit and loss account but will be added back in each of the Financial years before calculating the corporation tax.

Client Entertainment

Monies spent on client entertainment (such as lunch or dinner) are not allowable expenses for corporation tax purposes. Let’s say the Profit and Loss account of a company shows a profit of £8,000 for a given year. Now, if this includes an expense of £500 under the Client Entertainment category, this would be added back to profits before calculating the corporation tax. In this case, 19% of CT rate will be applied on £8,500 rather than £8,000.

Fines and penalties

Fines or penalties suffered by the company are also disallowable for corporation tax purposes. The same method of adding back (as explained earlier) will be applicable for corporation tax calculation. List of fines and penalties falling within the scope of this type of disallowable expenses can be found on HMRC website.

 Capital Allowances

Assets, as discussed above, are depreciated in every useful year of their life but this cost is not allowable for corporation tax purposes. To compensate for this, HMRC allows for Capital Allowances to be claimed for fixed assets in the Business. One of these allowances is the Annual Investment Allowance which is deducted from the profits before calculating the corporation tax and hence reducing the corporation tax bill.

Let’s say a business purchases fixtures that are eligible for Annual Investment Allowance claim. Total purchase price of these fixtures was £10,000. Under the Annual Investment Allowance claim, business would be allowed to claim the full cost of £10,000 before arriving at taxable profits. 

Losses

HMRC allows for losses incurred in previous accounting periods to be brought forward and offset against the current year profits. Under this principle, if a company incurs a loss of £5,000 in the previous accounting period and earns profit of £10,000 in the current accounting period, the total profit subject to corporation tax in the current year would be £5,000.

Corporation Tax Rate

From accounting perspective, it is self-evident that if the corporation tax rate changes during a tax year, the change cannot be applied in a universal manner to all companies due to each company having their Accounting Periods ending in different months of the year. For this reason, any changes in corporation tax rate are applied by apportioning the profits for relevant months. So, the profits arising during the months falling under previous rate would be calculated by the relevant corporation tax rate and later profits would be subject to the new tax rate.

Other Adjustments

There can be other adjustments depending on the nature of expenses incurred and capital allowances available. We advise that you seek professional advice for correct calculation of corporation tax.

At UGS Accountants, we offer specialised advice and support to new and developing small businesses. We recognise the importance of how different each business and its needs can be. For this reason, we proactively work with you to make the structuring of business, preparation of your accounts, bookkeeping, VAT and tax return a highly beneficial process, not merely a statutory one.

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Sole trader vs limited company–Which business structure is more beneficial?

It is vital to have the right business structure when you first set up your business. Financially, commercially as well as tax-wise, business structure will have long-term and lasting impact on your business and it’s sustainability. Rather than discuss the different liability between sole trading and limited company, this blog will prefer the tax implications of trading as sole trader or limited company.  In general, this widely debated topic affects the owner-managed small businesses, contractors and freelancers.

Sole trader – a brief introduction

Different from Limited company, when an individual sells his or her services or products themselves, it will be classified as sole trade and the concerned individual as Sole Trader. From tax perspective, sole traders are required to register with HMRC to file an annual self-assessment or tax return to report their income and expenses for each tax year.

Following points are important when trading as sole trader:

  • Rate of tax sole traders pay depend on the level of profits for each tax year.
  • In term of VAT, HMRC requires businesses including sole traders to register for VAT once their turnover reaches the VAT registration threshold. For 2018-19 tax year, this threshold is set at £85,000.
  • VAT registration can also be voluntary when business turnover is under the set threshold. (This point will be discussed in our follows blog)
  • Sole Traders can also register as Employers if they hire any staff to work in the business.

Limited company – a brief introduction

An individual can register a limited company to do business. All limited companies need one or more director as it’s owner. For the purposes of this blog, we assume a single individual as sole director and shareholder of the limited company. It is also worth noting that limited company is treated as a separate legal entity from its owner (YOU). We shall explain this and relevant legal consequences further in a separate blog.

Being the director and shareholder of a limited company – you assume the responsibility of running, managing and developing the business. You can take the salary, and when the company is profitable, you are entitled to withdraw the profits as shareholder in the form of Dividends.

Following points are important when trading as Limited Company:

  • Company registration is required with Companies House.
  • Corporation tax registration and administration is dealt with by HMRC.
  • Director can withdraw salary as well as take dividends from company profits (dividends can only be withdrawn from profits after company expenses, salary and corporation tax are paid). There might be a personal tax liability of the Dividends withdrawn.
  • In term of VAT, HMRC requires companies to register for VAT once their turnover reaches the VAT registration threshold. For 2018-19 tax year, this threshold is set at £85,000.
  • VAT registration can also be voluntary when the company turnover is under the set threshold. (This point will be discussed in our follows blog)  

Tax Implications Sole trader vs Limited Company

After understanding the structural differences between the sole trader and limited company, let’s now look at the tax implications of choosing either of these business structures.

Sole Traders

Sole traders pay tax on their profits each tax year. Tax is paid on any profits earned above the personal tax allowance of an individual. Income tax rates start with 20% for basic rate taxpayers with additional rate of 45% for income over £150,000.  Sole traders also pay Class 2 and Class 4 NICs on their profits.

Class 4 national insurance

This is calculated on self-employment profits. For 2018-19, It is calculated and payable at 9% of profits between £8,424 & £46,350 and 2% for any profits above this.

Class 2 national insurance

It is payable at a rate of £2.95 per week when business profits are above £6,205.

Limited Company

Corporation Tax

For 2018/19, corporation tax rate for limited companies is 19%.

Tax on Salary and Dividends

Directors withdrawing salary and dividends will be taxed under relevant income tax rates depending on individual circumstances and level of income for each tax year.

For 2018/19, directors can draw a tax free salary of £8,424 in 2018/19 under the personal allowance of £11,850. In addition, rest of £3,426 from personal allowance can be withdrawn as Dividends along with £2,000 of tax free dividends above the personal allowance.

Business Structuring Cost

Registration

  • Sole trader structure is easy to set up with free registration with HMRC for self-assessment.
  • Limited Company is registered with Companies House and incurs a small registration fees.

Statutory Duties

Sole Traders

  • Sole traders file self-assessment for each tax year.
  • You will require business insurance if applicable in your profession or trade.
  • Register as Employer with HMRC if you have employees.
  • You are responsible to pay any Tax and NICs via self-assessment.

Limited Company

  • For limited company, director’s are legally responsible to file the annual accounts and file corporation tax returns.
  • Directors will have to file their own self-assessment (if required by HMRC) to account for their own taxes.
  • Limited company also needs to have designated registered address.
  • Limited company will also maintain its own business insurance.
  • PAYE scheme will be required to run staff payroll.
  • Confirmation statement to confirm the business address and shareholding details will need to be filed once a year.

Take Home Pay – Which structure wins?

Following table summarises the advantages of having a limited company over sole trader at various profit levels:

ProfitLTDSole TraderAdvantageous
40,00032,48931,375Ltd by £1,114
50,00039,92838,000Ltd by £1,982
60,00046,51243,800
Ltd by £2,712
70,00051,97949,600Ltd by £2,379
80,00057,44755,400Ltd by £2,047

Please note that there are other factors which might lessen the ultimate take home figure and expert advice should be obtained before making your decision.

Decision Time!

It is evident from the issues discussed in this blog that choosing between sole trader and limited company structure is a complex endeavour.

As a whole, limited company offers more tax-efficient business structure, nonetheless, all material factors should be factored in before making the final decision.

At UGS Accountants, offer specialised advice and support to new and developing small businesses. We recognise the importance of how different each business and its needs can be. For this reason, we proactively work with you to make the structuring of business, preparation of your accounts, bookkeeping, VAT and tax return a highly beneficial process, not merely a statutory one.

Read more