Tax planning in its simplest form

Nearly everyone who has their business up and running will want to make sure they’re claiming expenses to reduce their tax bill.

However, there are a number of rules that need to be followed.

The expense must be incurred wholly and exclusively for the purpose of running the business.

If the expense has a dual purpose i.e. personal mixed in with business, it won’t be allowed by HMRC. As an accountant, I can’t claim the cost of my suit as it has two purposes – one is business but the other is to provide personal decency.

Another example is if you decide to extend a business trip abroad for leisure purposes, you can only claim for the business days, not the additional leisure days.

There are some expenses that HMRC will disallow, namely entertainment, so all invoices should be kept just in case HMRC open a check or an enquiry into the accounts and the expenses.

As you’re getting your business up and running, it’s entirely possible that you’ve incurred business costs prior to forming your limited company. You can claim “pre-trading” expenses for things like:

  • Computer equipment and software
  • Domain name registration
  • Office rent
  • Business insurance
  • Stationery
  • Accountancy costs
  • Travel costs

Should I operate as a sole trader or limited company?

That is a frequently asked question and the answer is, “it depends”.

Operating as a sole trader is the simplest and cheapest in terms of compliance costs. An annual tax return is prepared to summarise the sole trader accounts with the profit being subjected to both income tax and national insurance. If there are two or more of you involved in the business then you may all come together and form a partnership with profit allocations being taxed as if you were a sole trader.

Operating through a limited company, however, gives the flexibility of when to extract the profits into the personal hand and the realms of income tax. So, for example, you may earn a huge profit one year and nothing the next. With a limited company, you could take 50% out each tax year, maximising the use of tax-free allowances and the tax brackets. Your accountant would be advising you as to the best way to extract the profits from the company. There are basically two ways, either through pay or by dividends. Each method has a different tax consequence so the accountant should be advising you on which is the most beneficial – which may be affected by other circumstances. Indeed they may throw into the mix a company pension contribution to reduce the profits. It won’t necessarily be the same for each business owner and so it’s important to seek the right advice.

Also, the flexibility of having a limited company enables you to set up a brand and bid for work that maybe you wouldn’t be able to get if you were just a sole trader.

When setting up a company, you’ll need to decide on:

  • the name – this must be unique and can be quite fun – but not if nothing comes to mind!
  • a registered office address – we do recommend that this isn’t a personal home address and at our accountancy firm we offer our office address as an option
  • the shareholders
  • the directors – these are the people whom the shareholders appoint to run the company on their behalf and indeed it may be the same people! As a director, you’re legally responsible for the company’s activities. All decisions must be for the benefit of the company and not an individual

Once a company is formed, it will come with a certificate of incorporation and documents called the memorandum and articles of association. The latter is effectively the company rule book.

Each year the company must file both accounts and a confirmation statement at Companies House (note – these are two separate documents) and a corporation tax return at HM Revenue & Customs.

For small companies, you’ll be pleased to know that you don’t need to file the profit and loss account (the balance sheet still does though), so no one can see a list of your income and expenditure.

There are various filing deadlines for these documents but once the company is into its second year, the accounts filing deadline at Companies House is nine months after the period end. The tax return filing deadline at HMRC is 12 months and then, to make it confusing, the corporation tax is due nine months and one day after the period end.

As I say, it can be confusing and indeed daunting so that’s why I’d always recommend a limited company appoints an external accountant to guide them along the right path.

We’re often asked if a business should register for VAT. Well, you don’t have a choice if your turnover exceeds the threshold. We recommend that you use accounting software to help determine whether you’re over the threshold or not. (For the 2020/21 tax year, the VAT registration threshold is set at £85,000).

A common trap is to use the turnover for a set accounting period or calendar year. When assessing the need to become VAT registered you must calculate the turnover on a 12-month rolling basis (the last 12 months from any point in time). If you don’t register within 30 days you’re likely to be subjected to a penalty.

If the threshold isn’t breached, you may still become VAT registered and, of course, there are some plus points:

  1. You may claim back VAT suffered on purchases if you have a valid vat invoice
  2. You tend to get credibility in the marketplace if VAT registered

Yet, on the downside you might:

  1. Price yourself out of the market if your client can’t recover the VAT element of your invoice
  2. You have more paperwork to do, although this is mitigated by good accountancy packages

There are various schemes in place which your accountant can discuss with you, such as the flat rate scheme; but with small companies, I at least recommend that the cash basis is looked into.

Under the invoice basis the VAT payable to HMRC every quarter is calculated by taking off VAT suffered on purchases away from VAT on sales invoices but with the cash basis the VAT used in the calculation is on invoices that have actually been paid.

VAT is often a tricky area and your accountant will be able to advise and if necessary, help you complete and file the returns.

Roger Eddowes
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Roger Eddowes

Roger trained at Edward Thomas Peirson & Sons in Market Harborough before working at Hartwell & Co, followed by Chancery, as a partner. He started Essendon Accounts & Tax with Helen Beaumont in 2014. Roger loves ‘getting his hands dirty’, working with emerging, small-to-medium and family businesses to ensure they receive the best possible accountancy advice. Using an extensive network of business contacts to leverage the best guidance and practical solutions, he has been called a Business Godparent due to his caring, hands-on approach.