Prepare for taxing times ahead
Jo Nockels, of TaxAssist Accountants, explains what to do when Income Tax arises, the various deadlines associated with it and offers some tips on how to plan and manage it
Whether you’re starting out under the wing of a franchisor or going it alone, understanding all of the tax liabilities you can face, when and why, is not easy. We all know being smart with your cash flow is important, but it is vital in the early days when the initial investment has happened and your business is establishing itself. In this challenging economic environment, cash flow management is even more important with deterrents for being late with tax payments and returns having increased significantly over the years as the Treasury tightens its belt.
Unlike registered companies, unincorporated entities such as sole traders and partnerships do not get taxed in their own right. It is the business owners that get taxed, according to their share of the business. Essentially, they are taxed on the net profit or loss of the trade.
Businesses of any type can choose their tax year end date. Typically, they will opt for a quiet time of the year. For example, businesses operating in the hospitality sector are unlikely to have their year-end during the summer holidays.
Alternatively, businesses might choose the tax year end (April 5), because it keeps the VAT, PAYE and accounts records easier to tie up.
Whichever year end you opt for, a sole trader or partner will be taxed on the profits in the accounting period according to which tax year it ends in, unless this is your first year. If this is your first year, then the period that goes on your first tax return will need to be from the business start date to the following April 5. Assuming that your first accounting period is no longer than 12 months, the normal basis rules will then apply for subsequent tax years.
The tax return and any tax due must be submitted to HM Revenue & Customs (HMRC) by October (if filing a paper return) following the end of the tax year or the following January (if filing online). See Example 1 below.
In the example, notice how having the year end less than two months later, has deferred the tax due by a whole year.
Some business owners like this delay because it gives them longer to pay their tax liabilities, others prefer to have their tax payments more aligned with the relevant accounting period. That way, if there are any spikes in profitability, there is not a big gap until the tax is due – by which time the profits could have been spent!
Also see that by filing online, you buy yourself an extra three months to file your return. However, leaving it until the last minute gives you no time to plan for paying the tax owed, so ‘the sooner the better’ for cashflow reasons. Also if you are owed tax, you will want to find out sooner rather than later.
Payments on account
In addition to the tax bill you pay by January 31, you may also be required to make ‘Payments on Account’ (POAs).
If your tax liability is more than £1,000 and less than 80 per cent of your tax is collected at source, POAs will be triggered. POAs are payments on account towards next year’s tax, and are half of the tax due for the current year.
One instalment is payable with the current year’s tax bill at January 31 and the second is paid on the following July 31. See Example 2 below.
Although POAs are deducted from the balance due at the following January 31, they can have a big impact on cash flow because essentially it means up to 150 per cent of the tax is paid.
POAs could be triggered at any point during the life of the business, but they can be a particularly nasty surprise for the newly self-employed.
Put aside at least a quarter of your profits for your income tax bill. Putting aside that much might not quite cover your entire tax liability, but it should cover the majority of it.
If you’re predicting your profits might push you into the higher rates of tax (profits of £45,000 and upwards), then put aside at least a third.
Try to get your accounts and tax return drawn up as quickly as possible after your year end. Having your accounts makes good financial sense, as you can assess how the business has performed and make better informed decisions about its progression.
Knowing what your tax liability is in advance, allows you the time to consider your cash flow and make arrangements as necessary.
The UK tax regime can be a maze of legislation, so I would always encourage you to engage an accountant.
They can consider any tax planning opportunities – to mitigate the tax altogether, or perhaps just defer it and buy you some time. They can also help you meet those deadlines and avoid any costly penalties.
Written by Jo Nockels
Jo Nockels, ACCA MAAT, is Training and Communications Manager, at TaxAssist Accountants, a franchise that has become the UK’s largest network providing tax and accountancy advice and services specifically for small businesses.
This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayers’ circumstances do vary and, if you feel that the information provided is beneficial, it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.