We speak to a lot of businesses, and the clear (and probably obvious) message is that they don’t like paying tax. They may recognise the importance and the reason for paying tax, but it still doesn’t make it any more palatable. However, there are quite a few ways to legally reduce your business tax bill, some of which you may already be using. We thought it would be useful to highlight 3 of the main ways, which are legal and can be taken by simply planning your affairs.
Income Tax and National Insurance
If you trade as a sole trader or partnership, you pay income tax and national insurance on your business profits. Income tax is currently 20% for profits over £8,105, rising to 40% for profits over £42,475. Class 4 NI is 9% of profits over £7,605, then 2% of profits over £42,475. Therefore, a sole trader making £30k of taxable profits will receive a tax bill of £6,395. In addition, there will be class 2 NI of £2.65 p/w (= £137.80 p/a).
However, an increasingly popular way of reducing the tax bill for your business is to incorporate – in other words, trade through a limited company. The tax bill would shift from you personally to the company, which pays corporation tax at 20%, but no NI. For the same business above, earning £30k profits and paying the director (i.e. you) the advised salary, the tax bill drops to £4,502 p/a, a saving in excess of £2k.
Cue health warning: a limited company may not be the best option for every business, there are legal obligations to adhere to and certain items of expenditure which are treated differently, but it may be an option worth considering and which we are more than happy to advise on.
VAT registration is compulsory when your business turnover over the last 12 months (which is a rolling measure) exceeds £77,000. In theory VAT is supposed to be a neutral tax; if you have to register for VAT, you simply increase your prices by the VAT amount – so sales of £100 would become £100 + £20 VAT = £120. However, anyone in business knows that this may not be viable, particularly where your customer base is private individuals who would effectively be getting a price increase of 20%. Depending upon your business, you may be able to reclaim input VAT on costs of stock and overheads, although this won’t fully bridge the gap.
An extreme case is hot food outlets, such as Chinese takeaways, where there is little input VAT to reclaim, but all sales are subject to VAT, and are made to private individuals who cannot reclaim this VAT and therefore suffer it as a cost. If their turnover is £76k, they have no legal requirement to register for VAT. However, if their turnover jumps to £78k, they must register for VAT, and the result – assuming that prices cannot be raised – would be an annual VAT bill of somewhere in the region of £12k. This is a significant barrier to growth.
There are a number of legitimate ways that you can keep your turnover below this threshold, including:
- Closing part of the week to suppress your income.
- Asking customers to buy their own materials.
- Ignoring the effect of large one-off contracts which are not part of your usual business
- Having a significant change in your business which means that your turnover level will drop.
These issues were covered in this blog in more detail.
Employer’s National Insurance
When you take on an employee and pay them in excess of £144 p/w, you have to pay employer’s NI, at the rate of 13.8%. For instance, an employee earning £200 p/w would cost you an additional £7.73 (£200 – £144 x 13.8%). Pay an employee £300 p/w and the employers NI jumps to £21.53 p/w (= £1,119.56 p/a). This is a ludicrous tax, it is a real cost disincentive to take more employees on. After all, shouldn’t the Government be trying to encourage employers to take more staff on? OK, there is a scheme for new businesses, but reports suggest that this is not having the impact that was envisaged.
So how to do you avoid this tax? By taking on part time employees. In the above scenario, if you took on 2 employees each earning £100, you are paying the same amount of wages, but not paying any employers NI, an annual saving of £401.96. There is obviously the issue about the kind of work which is being done, and it may be easier to employ one person, but you would be giving yourself more flexibility in terms of sickness and holidays – i.e. if you have 2 people working part time and one is sick, there is a good chance that the other person would be able to provide cover.
So there you are, 3 areas of tax which many businesses face and which can be reduced or avoided. Please note that there may be other issues affecting the taxes mentioned above that are specific to your business/circumstances, and we would always advise you to seek professional help in clarifying whether these courses of action are relevant for you.