Income tax, VAT & legal form of business

Disclaimer: While every effort has been made to ensure the accuracy of the information contained in the Pink Book, we regret that we cannot be responsible for any errors. The Pink Book contains general information about laws applicable to your business. The information is not advice, and should not be treated as such. Read our full disclaimer.

Key facts

• You must establish your income tax position and whether you are claiming all the expenses and capital allowances you are entitled to.
• There are different tax and legal implications, depending on whether you operate your business as a sole trader, a limited company, a partnership or a charity.
• Tax and VAT are very large and complex areas of legislation that are constantly being revised and amended. For this reason, you should contact your accountant or financial advisor to discuss all related issues.

Income tax

It is important that you establish your income tax position and whether you are claiming all the expenses and capital allowances you are entitled to claim.

You must keep records of your business income and expenses for your tax return if you are self-employed as a:

• sole trader
• partner in a business partnership (if you're the nominated partner in a partnership, you must also keep records for the partnership)
• charity.

There are different rules on keeping records for limited companies and you should consult an accountant for advice if your business is structured as a limited company.

Regardless of whether you are a sole trader, a partner in a business partnership or run your business as a limited company, you will need to keep records of your personal income.

Many businesses use traditional accounting where you record income and expenses by the date you were invoiced or billed. However, there is an option of using cash accounting if you are a small business.

Cash basis accounting

The Government has introduced a 'cash basis' tax scheme for self-employed individuals or partnerships carrying on the smallest trading businesses.

You can use cash accounting if:

• you run a small, self-employed business as a sole trader or partnership (you cannot use the scheme if your business in is a limited company)
• you have a turnover of £150,000 or less a year.

You can stay in the scheme up to a total business turnover of £300,000 per year. Above that, you’ll need to use traditional accounting for your next tax return.

VAT Cash Accounting Scheme

In addition to the cash accounting scheme, there is also the VAT Cash Accounting Scheme. Under this scheme, you:

• pay VAT on your sales when customers pay you
• reclaim VAT on your purchases when you have paid your supplier.

To join the scheme, your VAT taxable turnover must be £1.35 million or less.

Further information is available on the cash basis accounting pages on the Gov.uk website. 

You can speak to an accountant or a financial advisor, or visit the HM Revenue & Customs (HMRC) website, which has a range of helpful information and contact numbers. 

VAT

VAT threshold

You do not have to register for VAT if your turnover for the previous 12 months is less than £85,000. This figure is known as the VAT registration threshold and is set at this level until 31st March 2024.

You must also register for VAT if:

• you think your VAT taxable turnover may go over the threshold in the next 30 days alone
• you take over a VAT-registered business as a going concern.

VAT deregistration threshold

The deregistration threshold is £83,000 and, as with the threshold, will be maintained at this level until 31 March 2024. If your VAT taxable turnover for the year falls below £83,000, or you expect it to fall below £83,000 in the next 12 months, you can ask to be deregistered for VAT.

Flat Rate VAT Scheme

If your VAT taxable turnover is less than £150,000, you can simplify your VAT accounting by calculating your VAT payments as a percentage of your total VAT-inclusive turnover. The current flat-rate VAT percentage for accommodation businesses is 10.5% and the rate for museums and cultural activities is 9.5% of your VAT-inclusive turnover. Once you join the scheme you can stay in it until your total business income is more than £230,000.

In 2017 the Government introduced changes to the Flat Rate Scheme for businesses with a very low-cost base. These businesses are now called 'limited cost traders'.

A limited cost trader is defined as one that spends less than 2% of its sales on goods (not services) in an accounting period. The amount spent on goods cannot include purchases of:

• capital goods (such as new equipment used in a business)
• food and drink (such as lunches for staff)
• vehicles or parts for vehicles (unless running a vehicle hiring business).

A firm can also be a limited cost trader if it spends less than £1,000 a year on goods, even if this is more than 2% of the firm's turnover on goods.

Limited cost traders can still use the Flat Rate Scheme, but their percentage is set at 16.5%.

It is recommended that you talk to your accountant as to whether joining the Flat Rate Scheme would be beneficial for your business.

For information go to The VAT Guide or contact the HMRC’s Helpline on 0300 200 3700, which is available from Monday to Friday, 8:00am to 6:00pm.

Setting Up a Charity

Some businesses, especially historic, cultural or environmental attractions, can be established as a charity. Charities don’t pay tax on most types of income as long as they use the money for charitable purposes. Charitable purposes that help the public can include:

• education
• religion
• community development
• the arts
• the protection of the environment
• animal welfare.

However, you may need to pay tax if you have:

• received income that doesn’t qualify for tax relief
• spent any of your income on non-charitable purposes.

Charities can also claim back tax that has been deducted e.g. on bank interest and donations (this is known as Gift Aid).

There are six steps to setting up a charity:

1. Find trustees for your charity - you usually need at least three.
2. Make sure the charity has a ‘charitable purpose for the public benefit’.
3. Choose a name for your charity.
4. Choose a structure for your charity. There are four different structures that have different responsibilities and obligations.
5. Create a ‘governing document’.
6. Register as a charity with the Charity Commission. You need to do this if your annual income is over £5,000, if you set up a charitable incorporated organisation (CIO) and if you want to get tax relief from HMRC.

Detailed information on how to set up a charity is available from the Charity Commission website.

Tax and your staff

For information on PAYE, National Insurance, download the Employer Further Guide to PAYE and National Insurance Contributions from Gov.uk.

There is a range of guidance available from the HM Revenue & Customs on their website and you can also contact the HMRC’s helpline: 0300 200 3200. You will need your employer reference number or accounts office reference number when you call.

Legal form of the business

There are different tax and legal implications depending on whether you operate your business as a sole trader, a limited company or a partnership. There are advantages and disadvantages for each category. You need to seek professional advice from lawyers or independent financial advisors.

Legal advisors

The Law Society is able to provide you with a list of solicitors within your area. Your local destination organisation may also be able to give you names of suitable local firms.

Independent financial advisors

The IFA consumer website allows you to find a list of independent financial advisors, accountants or solicitor in your area.

Making Tax Digital

Making Tax Digital is a major HMRC initiative to move all business accounting to a digital format. This is a staged process over the next five years.

The first component of Making Tax Digital is VAT payments. All VAT-registered businesses with a taxable turnover above the VAT threshold (£85,000) are now required to follow the Making Tax Digital rules by keeping digital records and using software to submit their VAT returns to HMRC.

The next stage of Making Tax Digital is to require self-employed businesses with an annual business or property income above £10,000 to follow the rules for Income Tax from their next accounting period starting on 6 April 2024.

Making Tax Digital will be extended to Income Tax Self-Assessment (ITSA) from 6 April 2024 for self-employed businesses with an annual income above £10,000.

For Corporation Tax, the Government has started to provide businesses with an opportunity to take part in a pilot ‘Making Tax Digital for Corporation Tax’ scheme and will not mandate its usage before 2026.