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How to Run a Tax Efficient Business
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How much tax you pay and how tax efficient your business is, will depend on the business's structure. When you're a sole trader or partnership, you will mainly pay income tax - if you've been an employee in the past, you will already be familiar with this.
When you run a limited company, the tax arrangement is slightly more complex. Your company is a separate legal entity in its own right. The company must pay corporation tax on its profits. Then, you need to decide how much income you can afford to take from the company. You can be taxed again on the income.
Consequences of bad tax management
If you fail to be efficient with business tax or use a tax efficient business structure, there can be serious consequences. When you fail to keep documents and records that ensure your tax management is accurate, you may end up paying extra.
When you don't keep records of estimated tax payments, or receipts for planned deductions, you can't claim them back as a business tax return. You will therefore end up paying more tax than you owe.
Much of your record keeping will be related to tax laws, so when you fail to keep them appropriately, you can face legal penalties too. If you are audited and don't have the correct paperwork to back up your claims, HMRC may decide you need to pay a higher amount.
You can also incur a financial penalty if you have not taken reasonable care in maintaining your records. If you end up owing extra, the penalty can be up to 30% of the extra tax due.
If HMRC concludes the error is deliberate, the penalty can be up to 70% of the extra tax due. Even if you maintain that the tax gap between what is submitted and actually due is accidental, HMRC can decide this is untrue and this can hit you where it hurts most: your profits.
What taxes must your business pay?
When you have set up as a sole trader, a partnership, or a limited company, you will be in a position to consider the type of taxes you must pay. In addition to whether you must pay income tax, or corporation tax, there are other taxes your business may need to consider.
Your business may need to pay business rates, National Insurance contributions and VAT. It some cases, it may even be more tax efficient for your business to be VAT-registered despite being under the VAT threshold. This can be complicated if you're new to the world of running your own business. It can also be time consuming, taking you away from your day-to-day duties to grow your company. This is why a lot of UK businesses seek expert help from an accountant to manage their tax efficiently.
According to research by IPSE, sole traders and freelancers spend an average of 20 days each year chasing up payments to balance the books. A massive 43% say they are doing extra work managing the books that they are not actually being paid for.
How many small businesses hire an accountant?
Despite the often-complex accounting system, 41% of small business owners and managers try to manage the company finances and accounting themselves. They choose not to employ skilled bookkeeping professionals trained to manage business finances in a tax efficient way.
Out of these, 30% have one employee who takes care of the accounting, even if they are not an accountant. Almost one-fifth (17%) of small businesses use a combination of external and internal accountants, while 13% use an external accountant only.
Dealing with accountants need not be time consuming: 18% of small businesses consult with their accountant only once a month, while 23% talk with them once a quarter. When choosing an accountant for your business, you can select one that suits your needs.
What about tax reliefs?
There are many acceptable ways you can reduce your tax bill, as long as you know what you're doing. The simplest way is to claim for genuine deductible business expenses.
These can include travel costs such as fuel, bus fair, train tickets and parking; office costs such as phone bills and stationery; uniforms; sub-contractor costs and salaries; raw materials and stock; financial expenditure such as insurance and bank charges; heating and lighting; business rates; marketing; and advertising costs.
You can also offset losses against your profits. If your business runs at a loss, including losses incurred from trading, property income, or selling assets, you may be able to claim tax relief on corporation tax by this means.
How easy is it to keep on top of all outgoings?
It can be challenging to keep on top of your outgoings if you're not a financial expert. According to surveys, almost two-thirds (60%) of small business owners feel they "aren’t very knowledgeable" when it comes to accounting and finances for their company.
Employing the services of a professional accountant, with expert knowledge of VAT accounting, can have many benefits for your business. An accountant can deal with all your VAT and other accounting headaches, leaving you with less administration work to drain your time.
You will find you're free to do the other important tasks of running and growing your business, without risking getting caught out by managing your finances incorrectly. Don't risk a fine, or a financial loss, by trying to complete complex accounting tasks if you don't fully understand them!
How many people struggle with bookkeeping?
It can be a false economy thinking you are saving money by doing the bookkeeping yourself. You could be failing to take advantage of legal accounting methods that can save you money. You could also be putting yourself at risk of financial penalties, should you make an error which HMRC discovers. Sadly, a lot of UK businesses get caught out with tax and later discover they are doing their bookkeeping wrong.
In 2020, 10.4 million business customers filed their taxes online through the self-assessment system. This included more than 700,000 who submitted their tax returns on deadline day and had a tight squeeze meeting the mandatory deadline. The peak time for filing was around 5pm - just seven hours before the cut-off point!
Unfortunately, 1.8 million people failed to file tax returns on time. This accounted for around 15% of the total returns due. With the services of an accountant, this error could have been avoided.