Income tax, VAT & legal form of business

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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 or a partnership.
  • Tax and VAT are very large and complex areas of legislation that are constantly being revised and amended. For this reason it is advisable to 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).

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

Regardless of whether you are a sole trader, partner in a business partnership or run your business as a limited company, you will also 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. Under this scheme, you:

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

You can use cash accounting if:

  • your business is registered for VAT
  • your estimated VAT taxable turnover is £1.35 million or less in the next 12 months. Further information is available on the Gov.uk website

You can speak to an accountant or a financial advisor, or visit the HM Revenue & Customs 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 (2019/20). This figure is known as the VAT registration threshold. The Government adjusts this figure regularly so it is important to check on the HMRC website to find the current level.

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 (2019/20). 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 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% 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, 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 16.5% rather than 10.5%.

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 National Advice Service on 0845 010 9000, which is available from Monday to Friday, 8:00am to 6:00pm. 

Tax and your staff

For information on PAYE, National Insurance, download the Employer Further Guide to PAYE and NICs

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 is able to forward you a list of independent financial advisors, accountants or solicitor in your area.

Making Tax Digital

Making Tax Digital is a major new initiative that will be implemented in 2019.

VAT-registered businesses with a taxable turnover above the VAT threshold are required to use the Making Tax Digital service to keep records digitally and use software to submit their VAT returns from 1 April 2019.

The aim of this initiative is to make tax administration more effectively through a fully digital tax system. This will apply to a wide range of taxpayers, including most businesses, self-employed people and individual taxpayers.

The main component is to require operators to maintain 'real-time' digital accounts for their business and to send quarterly summaries of their income tax and national insurance obligations to HMRC. To help facilitate this, the Government has worked with software developers to create appropriate accounting software for businesses.