UK Tax System Simplified
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, PAYE, Self Assessment and VAT.
Corporation Tax
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. This means the more profit a company makes, the higher the tax will be. The current Corporation Tax rate is 25%, however, not all businesses need to pay at this level – there is a ‘small profits rate’ for businesses with profits up to £50,000 whereby the rate of tax is 19%. A marginal rate is applied to profits between £50,000-£250,000. Each year 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.
PAYE
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 along with the employers’ National Insurance contributions. During the 2024/25 tax year, employers make National Insurance contributions at 13.8% of an employee’s salary above £9,096.
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 2024/25 tax year allowance is £12,570 each year. 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-£125,140 and £125,140+ respectively. There is a common misconception that your take-home pay is higher if you are on a salary of £50,269 than on £50,271, this is not the case as you only pay tax at a higher rate on the amounts earned above the threshold – so if your salary was £50,271 then only £1 of your income would be taxed at the higher rate of 40%.
Self Assessment
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, etc. Student loan repayments and child benefit 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 Self Assessment bill 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 31st January and 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 2024/25 tax year. In addition to the personal allowance, the first £500 dividends that you take within a tax year are tax-free.
Capital Gains Tax is also payable through the Self Assessment process – this is the tax on the profits on the sale of certain assets, eg, stocks, bonds, precious metals, real estate, and property. There is an Annual Exempt Amount of £3,000 meaning individuals don’t have to pay tax on their first £3,000 of Capital Gains each tax year.
VAT
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 included in the selling price, you pay VAT to the shop and then the shop pays that VAT to HMRC.
When a company’s taxable turnover exceeds £90,000 then they will need to register for VAT. Once registered, most companies have to submit quarterly VAT Returns which shows HMRC the VAT you have 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.
There are two main schemes that companies use to submit their VAT Returns; cash scheme and accrual scheme. When a company is on the cash scheme, they only pay/reclaim VAT on sales on purchases where the cash transaction has taken place within the quarter, whereas VAT Returns prepared on the accrual scheme include sales and purchases based on their tax point (usually the invoice date). Being on the cash scheme is usually beneficial for a company’s cash flow because VAT isn’t paid to HMRC on any unpaid sales invoices – however, this scheme is only available to companies 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.
