Guide to small business tax

Here we discuss the ins and outs of small business tax, including corporation tax, income tax and national insurance.

Starting your own business can be extremely rewarding but there are lots of financial commitments to consider. You will need to pay small business taxes, including corporation tax, if you start your own company.

In this article, we explain:

• What tax do small businesses pay?
• How much do I pay in income tax and national insurance?
• What are the new corporation tax rates?
• Do I need to pay VAT?
• What are business rates and how do they work?

Read more: Use our income tax calculator to find out your take home pay

What tax do small businesses pay?

Small businesses are liable to pay income tax and national insurance, corporation tax, VAT and business rates.

You may not need to pay all of these. But there are certain allowances and reliefs that you could be eligible for, which would reduce your tax bill.

Remember that if you employ staff you will need to set up payroll. You should ensure your employees pay the correct amount of income tax and national insurance. Depending on their age and income, you should pay them a pension too.

If you are looking for a pension for yourself, check out our guide on the best pension for self-employed workers.

Small businesses’ investment allowance

Jeremy Hunt increased the smaller businesses’ annual investment allowance to £1million in his 2023 spring budget. This allows 99% of all businesses to deduct the full value of all their investment from that year’s taxable profits.

The chancellor also introduced “full expensing” for the next three years – this is where every pound a company invests in IT equipment, plant, or machinery can be deducted in full and immediately from taxable profits – and made it permanent in his Autumn Statement 2023.

Income tax and national insurance

This is the bread and butter of tax. The government loves income tax and national insurance because it makes so much money from them. More than 40% of total receipts come from the wages of 31 million Brits.

If you’re a director of your own company you are classed as an employee. This means you will pay tax on any earnings over the £12,570 tax-free allowance.

“Earnings” includes salary, of course, but don’t forget about rental income and any dividends from the business.

Income tax

As a company director, your salary will be paid and taxed in the same way as that of your staff, through the PAYE system, with what you owe the taxman being deducted before you see the cash.

Take a look at the income tax rates for the UK (excluding Scotland) and for Scotland.

Wondering how much tax you’ll pay in a whole year? Find out by using our income tax calculator.

Most directors take part of their income as dividends and the first £1,000 is tax free.

Above this, dividends are taxed at 8.75% for basic-rate taxpayers; 33.75% for higher-rate taxpayers; and 39.35% for those who fall into the additional-rate category.

But before you jump for joy at these rates, remember the company will already have paid corporation tax of at least 19% on this money. More on corporation tax later.

National insurance

National insurance is a tax in all but name. Everyone who’s over the age of 16 and under state pension age, and earning above a certain threshold, needs to pay NI contributions.

These are used to build up your state pension entitlement and to help pay for some public services and benefits.

As employees, directors pay national insurance on income from salary and bonuses over £12,570.

Companies, too, pay employers’ national insurance on directors’ salaries. Dividends are a different matter though as no NI is due from either the company or the recipient. As a result, company owners normally take a combination of salary and dividends to make the most of their tax allowances.

If you want to know about paying tax and national insurance as a sole trader, check out How to pay taxes as a freelancer.

Payroll

It is not enough to make sure that you yourself pay income tax and NIC, you have to ensure that any staff do too. For that you need to register your company as an employer with HMRC before the first pay day, but no more than two months before.

You have to do this even if you’re only employing yourself as, for example, the only director of a limited company.

You do not need to register for PAYE if none of the employees, including yourself, are paid more than £120 a week. But if any employees in receipt of a pension, have another job or get benefits from the company, such as a car, then you do have to register.

To pay your staff and ensure the correct tax and NI deductions are made you’ll do what’s known as “run payroll”. This is a system that you either run yourself or outsource to a specialist company.

Other contributions

As well as tax and NI, you’ll be responsible for deducting student loan repayments and pension contributions. If you run payroll yourself, you’ll need to report your employees’ payments and deductions to HMRC on or before each payday.

You usually have to pay the taxman what you owe every month, however if you expect to pay less than £1,500 a month, you can arrange to make payments quarterly – contact HMRC’s payment enquiry helpline.

As part of your regular reports, you should tell HMRC when a new employee joins and if an employee’s circumstances change, for example they reach state pension age or become a director. You have to run an annual report just before the end of the tax year and submit it to HMRC.

Payroll can be quite complex but outsourcing to a provider costs money so you have to think carefully about what is the best option for your new business. 

Corporation tax

Jeremy Hunt’s 2023 budget included a corporation tax hike which will affect businesses. The current corporation tax rate is due to increase from 19% to 25% from April. In order to limit the impact of the increase, the chancellor has allowed businesses to offset 100% of investments in infrastructure and factory and machinery assets against profits for tax purposes. The move is meant to enable companies that invest in the UK to significantly reduce their tax bills.

Hunt confirmed small or medium-sized businesses will be able to claim a credit worth £27 for every £100 they spend. However, this perk only applies if the small business spends 40% or more of its total expenditure on Research and Development.

Corporation tax is the chicken dinner of tax. Another classic for the taxman, and while other taxes taste a bit like it, they just aren’t corporation tax.

It is similar in concept to income tax but only for businesses and is based on profit not earnings. Also, unlike income tax, there is no personal allowance, so as soon as your business starts making a profit, you have to pay.

Registering for corporation tax is one of the first things you have to do as a small business, and it needs to be done within three months of starting to trade, that means if you start selling, buying, taking on staff, advertising or renting an office. The taxman loves a fine, so don’t miss that deadline. 

The corporation tax rate is 19%, and has been since April 2017. In April 2023 the rate of corporation tax will rise to 25% for companies with profits over £250,000.

When you pay it is different from other taxes

The deadline is nine months and one day after the end of your accounting period (usually your financial year), so if this ends on March 31, you need to work out what you owe and pay by January 1 of the following year.

This is the case for businesses with profits up to £1.5m, but if you’re in the lucky position of generating more than this, you’ll have to pay up more promptly, and in instalments.

As I’ve mentioned, corporation tax is based on profit, and your company’s profit is its income minus the expenses of running the business.

These might include office rent, salaries, stationery, and phone and utility bills. Once you’ve worked out the profit, you need to pay 19% of that sum to HMRC in corporation tax.

It’s worth mentioning that if you buy things that will be kept for the use of the business, such as vehicles, machines or expensive software and technology, the cost can’t be deducted from your company’s income but you may be able to claim capital allowances instead to reduce your tax bill.

Don’t forget that there’s corporation tax to pay if you sell a business asset and make a profit. It’s a bit like capital gains tax.

VAT

This is the salt and pepper of tax. Before you buy most goods or services in the UK, they will be given a sprinkling of VAT or value added tax, generally set at 20%. 

Legally your business has to register for VAT when turnover tops £85,000. The company then has to charge customers an extra 20% on their bills. However, you can claim back any VAT on products on services that the business pays for. VAT is kept separate on invoices and paid online to HMRC throughout the year.

If your business turns over less than £150,000, it may make sense to register for HMRC’s VAT Flat Rate scheme so you don’t have to record VAT for individual purchases and sales. The idea is to make the whole process much simpler. You still charge customers the basic rate of VAT but only pay HMRC a fixed rate.

On April 1, 2019, the government brought in Making Tax Digital (MTD) for business, requiring all VAT registered businesses to use MTD compatible software.

Business rates

This is the brussels sprouts of tax. Universally unpopular, business rates are one of the largest overheads for businesses and substantially impact on profitability.

They are payable by any company that is run from an office or a shop. You may also have to pay if you have customers visiting your home or you have converted part of it for work. Some premises are exempt from business rates, such as places used for the welfare of disabled people, and farm buildings. 

Your local council will send you a business rates bill in February or March each year, for the following tax year. It is based on the property’s “rateable value”, but if you think this figure is wrong, contact the Valuation Office Agency (VOA) as you may be able to appeal against it.

You could seek to reduce your bill by applying for business rates relief from your local council. The process depends on whether you’re in England or Wales.

There are a number of other tax relief schemes and grants available, such as rural rate relief and charitable rate relief. The Autumn Statement 2023 announced that the business rates reduction of 75% for the retail, hospitality and leisure relief will be extended another year, affecting 230,000 properties, and the freeze to the small business multiplier is also being extended.