In short, the government uses tax to help control inflation, increase employment and encourage/discourage certain behaviours, like encouraging charitable donations by offering Gift Aid tax relief and discouraging sugary drinks by introducing a sugar tax.
HMRC is a department of the UK Government that is responsible for the collection of taxes. There are 4 main taxes that owner-managed businesses should be familiar with; Corporation Tax, Self Assessment, PAYE and VAT.
A financial year is a period of twelve months used by businesses to calculate their budgets and profits – Corporation Tax is a direct tax that limited companies are required to pay on those profits, which is 19% until 1st April 2023 when it will be increasing for businesses with profits above £50,000. In the main, the more profit a business makes, the higher its tax will be. Each year limited companies have to submit a set of statutory accounts along with a Corporation Tax Return, the tax calculated on the return needs to be paid within 9 months and one day after the end of the financial year.
Self Assessment is the method used to declare and pay personal tax – the tax imposed on an individual’s income throughout the year, eg salaries, dividends, interest and other income. Student loan repayments are also made through the Self Assessment process.
Unlike the financial year, the tax year is fixed and it runs from 6th April to 5th April – the online filing deadline is 31st January in the following year. The payment deadline for any tax you owe for the previous tax year is also 31st January. If your personal tax exceeds £1,000, then you will also have to make payments on account which is half of your previous year’s tax bill due on both the 31st January and also 31st July.
You are taxed at different rates depending on whether you are a basic rate, higher rate, or additional rate taxpayer – 20%, 40% or 45% respectively for regular income tax and 8.75%, 33.75% and 39.35% for dividend tax for the 2022/23 tax year. In addition to the personal allowance, the first £2,000 dividends that you take within the tax year are tax-free.
The PAYE (Pay As You Earn) system is a method of paying income tax, National Insurance contributions and repaying student loans. The employer deducts these from the employees’ wages which are then paid to HMRC by the 22nd of the following month. For the 2022/23 tax year, the employer is also required to make National Insurance contributions of 15.05% on employees’ earnings that are above £758 each month.
UK citizens have a personal allowance which means that they are able to earn up to a certain level of income before they start paying tax, the 2022/23 tax year allowance is £12,570. Above the personal allowance, tax is charged at 20%, 40% or 45% depending on whether you are a basic rate, higher rate, or additional rate taxpayer – £12,571-£50,270, £50,271-£150,000 and £150,000+ respectively. There is a common misconception that you are paid more if you are on a salary of £12,569 than on £12,571, this is not the case as you only pay tax on the amounts earned above the tax-free threshold – so if your salary was £12,571 then you would be taxed on £1 at 20% meaning you would have to pay 20p of income tax.
VAT is an indirect tax, meaning that the tax is paid to HMRC indirectly through an intermediary. For example, if you purchased a new laptop from a shop with VAT on it, you pay VAT to the shop, the shop will then pay the VAT amount to HMRC.
When a business’ taxable turnover exceeds £85,000 then it will need to register for VAT. Once registered, most businesses have to submit quarterly VAT Returns which show HMRC the VAT that has been collected through sales and also the VAT that is going to be reclaimed through VATable purchases made. The VAT Return needs to be submitted and paid by one month and seven days after the end of each VAT quarter. HMRC grant an additional 3 working days to the payment deadline if the liability is paid via Direct Debit.
The two most common schemes that businesses use to submit their VAT Returns are the VAT Cash Accounting Scheme and the VAT Accrual Scheme. When a business is on the cash scheme, they only pay/reclaim VAT on sales and purchases where the cash transaction has taken place within the quarter, whereas VAT Returns prepared on the accrual scheme include invoices and purchases based on their tax point (which is usually the invoice date). Being on the cash scheme is usually beneficial for a business’ cashflow because VAT isn’t paid to HMRC on any unpaid sales invoices – however, this scheme is only available to businesses with a turnover of under £1.35 million.
This is only a general guide for dealing with tax as there are a lot more complexities. Always refer to HMRC guidance or speak to MAP to avoid non-compliance.