Practical tax information to help you navigate through the tax system and plan tax efficiently by providing you with an overview of the key tax rules.
Throughout this guide you will find a number of tax tips and checklists to help you identify planning opportunities, pitfalls to avoid and areas where you may need to take action. We would be happy to help with advice on your specific position.
The rules, rates and allowances in this guide relate to the 2025/26 tax year and these may be different for other tax years.
Running a business
Starting up a business of your own is a big step and not one to take lightly. The taxation of your business is only one of many commercial and legal aspects of starting a business that you will need to consider.
Choosing a business structure
The alternative business structures are:
Sole trader
This is the simplest form of business structure since it can be established without legal formality.
The business of a sole trader is not distinguished from the proprietor’s personal affairs. If the business incurs debts which are unpaid, the creditors can seek repayment from the sole trader personally.
Partnership
A partnership is similar in nature to a sole trader but involves two or more people working together.
A written agreement is essential so that all partners are aware of the terms of the partnership. Again, the business and personal affairs of the partners are not legally separate.
Sole traders and partnerships are often referred to as unincorporated businesses and the individual owners as self-employed. The trading profits of both sole traders and partnerships are subject to income tax.
Limited company
A company is a legal entity in its own right, separate from the personal affairs of the owners and the directors.
A company provides protection from liability, which means that the creditors of the company cannot make a claim against the owners or the directors except in limited circumstances.
Companies are subject to corporation tax and individuals are only subject to income tax on any funds withdrawn from the company by way of salary or dividend, for example. In the past, this has been an advantage of incorporation as corporation tax rates have been lower than income tax rates. The recent increase in corporation tax has eroded that tax advantage for companies with larger profits.
Operating as a company carries the downside of greater legal requirements and regulations that must be complied with.
Limited Liability Partnerships (LLPs)
LLPs are a halfway house between partnerships and companies.
They are taxed in the same way as a partnership but are legally a corporate body. This again gives some protection to the owners from the partnership’s creditors.
In this guide we consider the differing tax treatments of the alternatives but you should choose which structure is right for you based on more than just the tax issues alone.
Taxation of unincorporated businesses
A new business should register with HMRC on commencing to trade. Income tax is paid on the profits of the business. The amount that the proprietor, or a partner in a partnership, draws out of the business is irrelevant.
Note that this section deals with the taxation of trading activities. Property businesses have some different rules and are dealt with in the Property investment section of this guide.
Do I have a trade?
There is no definition in the legislation of a trade; per HMRC’s guidance ‘broadly, ‘trade’ can be taken to refer to operations of a commercial kind by which the trader provides to customers for reward some kind of goods or services’. A number of ‘badges of trade’ exist including repeated operations and connection with existing trade which can help inform whether an activity is an isolated event or trading in nature.
It is worth noting that HMRC is targeting activities which they consider to be potential trades based on the information they collect from external sources. As examples, digital selling platforms are now required to make annual reports to HMRC for anyone who sells 30 or more items or earns approximately £1,700 or more in a calendar year. HMRC also conducted a One to Many campaign where they sent out correspondence directed at individuals who carried out deliveries during the tax year 2023/24 and weren’t registered for Self Assessment (SA) or paid via PAYE for this work.
If you earn income from an activity which you are not paying tax on, we can help you ascertain whether this would be considered trading.
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If you have trading income of £1,000 or less, it is covered by the trading allowance and you do not need to declare or pay tax on that income. If you have income above the allowance you are able to calculate your taxable profit either by deducting their expenses or by simply deducting the £1,000 trading allowance. |
Basis of taxation
An individual will be taxed on any profits arising from the 6 April in one year to the 5 April in the next; this is known as the actual or tax year basis. This may add significant complexity to calculating the income tax payable for a trader who does not have an accounting year end between 31 March or 5 April as the profits will need to be apportioned into the tax year. We would be happy to assist you with these calculations.
For many businesses, the profits which are taxed in a tax year are calculated using the cash basis as the default. Under the cash basis, business profits are taxed on cash receipts less cash payments of allowable expenses. As the individual is only taxed on income actually received, they will not be subject to income tax on sales receipts paid late until those amounts are actually paid.
A business can elect to apply the accruals basis instead which means profits are calculated based on income receivable less expenses payable for a tax year regardless of whether these amounts are paid. The optional accruals basis requires an election by the business owner for the year in which it is to apply. The election will stay in place until revoked by the business.
Other than the timing of taxation for sales and expenses, one of the main differences of using the accruals basis is the treatment of capital assets. Under the cash basis, the cost of most purchases of plant and machinery is deductible when paid (cars being the main exception). Similarly any cash proceeds from the disposal or plant and machinery are taxable on receipt. Under the accruals basis deductions for the use of capital assets are given through capital allowances which are explained further below.
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The cash basis can be much simpler than the accruals basis to apply for small businesses and means individuals aren’t taxed until the cash is actually received which can be beneficial to businesses where most sales are made on credit. |
Do get in touch if you would like us to consider which scheme is appropriate for you and your business. There are transitional adjustments which apply when moving from one basis to another so please do seek advice if you are thinking of doing this.
Allowable expenses
Not all of the expenses that a business incurs are allowed to be deducted from income for tax purposes. It is important that you keep proper and comprehensive business records so that relief may be claimed.
Non-deductible expenses include those which are not wholly and exclusively for the purposes of the trade. Client entertaining and private expenses of the sole trader are common examples of this. Private expenses can include either wholly personal expenditure such as advice on the sole trader’s income tax return or expenditure with an element of private use or benefit such as motor expenses for a car a sole trader uses for both personal and business purposes. In the latter case, it may be appropriate to pro-rate the expense between allowable (the business element) and disallowable (the private element).
Training expenses are generally considered wholly and exclusively for the purposes of the trade if these help you to improve the skills and knowledge you currently use for the business or to support your business (e.g. administrative skills) or to develop new skills to adapt to changes in your industry or for technological updates. Training expenses would not be deductible if they were incurred in relation to starting a new business or expanding into a new area which is not related to what you currently do.
We can help you ascertain which expenses are deductible from your trade.
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You may choose to use simplified expenses for certain types of expenditure. This may be a more straightforward approach for vehicles where you have both private and business use or where you work from home. Simplified expenses give a flat rate deduction for business miles or hours worked at home instead of needing to apportion the total expenditure. They are also available to work out the allowable costs where you live at your business premises e.g. you operate a B&B. |
Capital allowances
When assets are purchased for the business, such as machinery, office equipment or motor vehicles, capital allowances are available to reflect the cost of the asset to the business. As with expenses, these are deducted from income to calculate taxable profit. The below allowances are available to companies and unincorporated businesses using the accruals basis or which purchase cars.
Plant and machinery
Plant and machinery purchased by a business is eligible for annual writing down allowances (WDAs) of 18% per annum for most plant and machinery and 6% per annum for certain expenditure which is ‘integral’ to a building such as air conditioning or water systems and other long life assets. These allowances are calculated on a reducing balance basis rather than straight line on cost.
Annual Investment Allowance
The Annual Investment Allowance (AIA) gives a 100% write off on most types of plant and machinery costs, but not cars, of up to £1 million per annum. Any costs incurred in excess of the AIA will attract ongoing WDAs as set out above.
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Capital allowances are available in full regardless of when the asset was purchased in the period (provided it has been brought into use). It may be possible to time a purchase to get a deduction under the AIA in a year when profits (and therefore tax) are higher. We can assist you with planning your capital spend. |
Motor vehicles
The AIA is not available on cars and annual WDAs on a car purchase depend on CO2 emissions. From April 2021 purchases of cars with emissions not exceeding 50g/km attract an 18% allowance and those in excess of 50g/km are only eligible for a 6% allowance. A first year allowance of 100% is available on new zero emission cars and electric charge points (if purchased before April 2026). Note that vans are eligible for the AIA and 18% WDAs regardless of the level of their emissions.
Structures and Buildings
Qualifying expenditure on the construction of new, or the renovation of, non-residential structures and buildings is eligible for Structures and Buildings Allowances (SBAs) of 3% per annum.
Unlike WDAs, SBAs are calculated as a straight line deduction based on cost over a time period of 33 ⅓ years. Where a building on which SBAs have been claimed is purchased, the purchaser takes on the remaining SBAs. Adjustments need to be made to the chargeable gains calculation when a property on which SBAs have been claimed is then sold.
National Insurance for unincorporated businesses
A self-employed individual is required to pay Class 4 NICs based on the profits of their business. Class 4 NICs are payable at 6% on profits between £12,570 and £50,270 and at 2% on profits in excess of £50,270.
From 6 April 2024, Class 2 NICs are no longer required to be paid by self-employed individuals. However, if you have profits below the small profits threshold of £6,845 per annum and do not otherwise pay NICs (e.g. on your employment income) you may wish to pay voluntary Class 2 NICs to preserve your entitlement to state benefits.
Losses
Sometimes a business may make a loss instead of a profit and there are particular tax rules to give businesses relief for that loss. Trading losses for unincorporated businesses can generally be used against an individual’s net income in either the current or the preceding tax year although certain maximum limits apply to larger losses. Any unused losses are carried forward against future profits from the same trade.
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You can choose how to make best use of any trading losses. Considerations will include the tax saving generated and using losses earlier rather than later for a cashflow benefit. We can assist you with calculating the benefit of potential options. |
Special rules apply where a trade has ceased; contact us if you think this might apply to you.
Companies
Unlike sole traders and individual partners in a partnership who are subject to income tax on the trading profits of the business, companies are subject to corporation tax on profits. In addition, individuals may be subject to income tax on the extraction of profits from the company; thus profits may be taxed on both the company and the individual.
However, there may be cash savings to operating as a company as the corporation tax rate will be lower in some circumstances than the applicable income tax rate on the profits.
Corporation Tax
The rate of corporation tax payable is dependent on the level of taxable profits in the company (plus certain dividends received by the company).
| Taxable profits | Corporation tax rate |
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£0 – £50,000 |
19% |
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£50,000 – £250,000 |
25% less marginal relief |
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Over £250,000 |
25% |
Unlike income tax bands, the corporation tax rate is applied to the total taxable profits of the company. Therefore a company with profits of £400,000 would have a corporation tax liability of £100,000 (being 25% of £400,000). The operation of marginal relief acts to gradually increase the rate of corporation tax from 19% to 25%.
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Marginal relief has the impact that any profits falling between £50,000 and £250,000 are effectively taxed at 26.5%. Therefore, maximising deductions available will be particularly important for those companies whose profits fall between these thresholds. We can assist you with identifying any claims for deductions for your business. |
Companies are taxed on the basis of their accounting period which typically aligns to the period for which the company prepares accounts.
Tax on profits
The profits of a limited company are calculated in a similar way as for unincorporated businesses and the same rules with regard to expenses and capital allowances generally apply.
Salaries paid to directors (but not the dividends paid to shareholders) are deductible from the profits before they are taxed. In addition, expenditure with an element of private use is not disallowable in calculating the profits subject to corporation tax; instead this may result in a benefit in kind for the director or other employee which is subject to income tax.
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Companies are a popular business structure as they may result in less tax being paid overall. |
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However, the saving is dependent on profits and withdrawals. We would be happy to discuss the implications of incorporation with you before you decide whether or not to incorporate your business. |
Capital allowances for companies - full expensing
In addition to the AIA and WDAs which are available to companies as well as unincorporated businesses, companies investing in qualifying new plant and machinery can claim:
- First year allowances (FYAs) of 100% on most new plant and machinery investments that ordinarily qualify for 18% WDAs; this is often referred to as Full Expensing.
- An FYA of 50% on most new plant and machinery investments that ordinarily qualify for 6% WDAs.
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Full Expensing will typically be most useful where companies or groups invest over the AIA of £1 million in new plant and machinery. |
Tax relief for expenditure on Research and Development (R&D)
Companies with expenditure in qualifying R&D activities can receive tax relief. This will typically take the form of a taxable credit of 20% of the qualifying expenditure which can be used to reduce the corporation tax liability, or potentially repaid in the case of loss-making companies.
R&D intensive companies will operate under a separate scheme, with enhanced relief where R&D expenditure accounts for 30% or more of total expenditure of the company.
This is a complex area. Please get in touch if you would like to know more.
Losses
Trading losses incurred by companies may be offset against total profits in the current year. After a current year claim is made it is possible to carry back trading losses for twelve months and offset against total profits. Note that, unlike for an individual, a current year claim must be made before a carry back claim. If there are any excess trading losses or a claim is not made the losses are carried forward and a claim may be made to offset against total profits in future periods.
Payment of tax
Corporation tax is usually payable nine months and one day after the year end but payments may be accelerated for large companies.
Tax on ‘drawings’
Directors of a company will normally be paid a salary and this is taxed under PAYE as for all employees. The cost of this, including the employer’s NICs, is generally an allowable expense of the company. Shareholders of the company in contrast may be rewarded by the payment of dividends on their shares. Dividends are paid out of profits after taxation.
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In most small companies the directors and shareholders are one and the same and so they can choose the most tax efficient way to pay themselves. Using dividends can result in savings in NICs. However, this requires careful planning, especially given the increase in corporation tax rates. Please talk to us to decide what is appropriate for you. |
Warning - close company loans to participators
A close company (which generally includes owner managed companies) may be taxed where it has made a loan or advance to individuals or their family members who have an interest or shares in the company (known as participators). The tax charge is currently 33.75% of the loan if it is outstanding over nine months after the end of the accounting period. The tax charge is repaid to the company nine months and one day after the end of the accounting period in which the loan is repaid.
Further rules prevent the avoidance of the charge by repaying the loan before the payment date and then effectively withdrawing the same money shortly afterwards. This is a complex area so please do get in touch if this is an issue for you and your company.
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Ensure that sufficient salary and dividends are drawn from the business to prevent these charges arising unnecessarily on an overdrawn director’s current account. We can also ensure that overdrawn accounts are cleared properly. Please contact us if you would like to discuss the right options for you and your business. |
Note that loans to participators who are directors or other employees in excess of £10,000 may also result in a benefit in kind for the individual which would be subject to income tax. This is dealt with in Working for others.
Employing others
As an employer you will have many responsibilities. These will include employment law requirements and the need to enrol workers into a work based pension scheme (Pensions Auto Enrolment) which are not covered in this guide.
Real Time Information
Real Time Information (RTI) reporting is mandatory for almost all employers.
Under RTI, employers or their agents are required to make regular payroll submissions for each pay period during the year. The submissions detail salary and other employment payments made to, and deductions such as income tax and NICs made from, employees. These submissions must generally be made on or before the date the amounts are paid to the employees.
The employer must also report details of expenses and benefits provided to employees.
National Insurance
An employer must pay employers’ or secondary Class 1 NICs on their employees’ earnings. This is calculated at a rate of 15% on earnings in excess of £96 per week.
An employment allowance of £10,500 may be set off against the employers’ class 1 NIC liability.
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The employment allowance is not available where the only employee paid above £5,000 per annum is a director; care should therefore be taken for recently incorporated sole trader businesses. |
Benefits
Where an employee is provided with benefits (see Working for others) then the employer is required to pay Class 1A NICs on the value of those benefits. The rate of Class 1A NIC is 15%.
Value Added Tax (VAT)
VAT is a tax ultimately paid by the final consumer and businesses act as the collectors of the tax.
What does VAT apply to?
VAT is chargeable on the supply of certain goods and services in the UK when made by a business that is registered for VAT (see later).
A registered business must charge VAT on its taxable supplies (broadly the sales made) which is known as output VAT. There are currently three rates of VAT which can be payable. These are the standard rate of 20%, the reduced rate of 5% and the zero rate.
The zero rate applies where the supply is deemed to be subject to VAT but the output VAT is charged at 0%, meaning that no VAT is actually payable.
A business also pays VAT on the goods and services it buys. This is known as input tax and may be reclaimed by a VAT-registered business.
If the output tax exceeds the input tax, then a payment of the difference has to be made to HMRC. If input tax exceeds output tax a repayment of VAT will be made. This calculation is generally done on a quarterly basis. However, where repayments occur regularly, it is possible to opt for monthly VAT returns.
Some input VAT is not reclaimable by a VAT-registered business. Two common examples are VAT incurred on entertaining UK business customers and VAT on the purchase of a car.
Certain supplies of goods and services are not subject to VAT at all and are known as exempt supplies. A business that makes only exempt supplies cannot register for VAT and will be unable to reclaim any input tax.
Do I need to register?
A business must register if its taxable supplies exceed an annual figure of £90,000. If taxable supplies are less than this a business may still register voluntarily. So, for example, if the business makes only zero-rated sales, it can still register and reclaim the input tax suffered.
VAT can affect competition. A plumber, for example, who sells only to the general public will be at a disadvantage if they have to register for VAT. They may have to charge up to 20% more than a plumber who is not VAT-registered to earn the same profit.
On the other hand, if the same plumber only works for other VAT-registered businesses, such as building companies, then it will not matter whether they are registered because the customer will generally be able to recover the VAT that is charged.
Indeed, it may be beneficial for a business that always sells to other VAT-registered businesses to register for VAT, even if below the annual limit, because then it can reclaim VAT on purchases and expenses. This will improve profit and can be especially relevant for new businesses because there are often high initial set up costs that carry VAT. Do note that VAT registration comes at the cost of having to meet record keeping requirements, a need to submit online VAT returns and pay VAT online and on time.
We can help you assess your situation and register for VAT if required or beneficial.
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When you first register for VAT you can reclaim input tax on goods purchased up to four years prior to registration provided they are still held when registration takes place. VAT on services supplied in the six months prior to registration may also be reclaimed. |
Making Tax Digital (MTD)
MTD for VAT
Making Tax Digital (MTD) for VAT is part of a government strategy which will ultimately require taxpayers to move to a fully digital tax system.
Under the MTD for VAT rules, all VAT-registered businesses must keep digital records for VAT purposes and provide their VAT return information to HMRC using MTD compatible software.
There are some exemptions from MTD for VAT. However, the exemption categories are tightly drawn and are unlikely to be applicable to most VAT-registered businesses.
We can help you to meet your MTD for VAT obligations.
MTD for income tax
MTD for income tax will be introduced in stages. Self-employed individuals and landlords with qualifying income over £50,000 will be mandated to apply MTD from April 2026. Those with qualifying income over £30,000 will be mandated from April 2027 and those with qualifying income over £20,000 from April 2028. The government will review the application of MTD for smaller businesses.
Similarly to MTD for VAT, businesses will be required to keep their records digitally and provide digital quarterly updates to HMRC through MTD compatible software.
We can help you assess when MTD will be required for your business and to meet your obligations.
We can help
Contact us if you:
- Are starting a new business
- Are considering incorporating a sole trader or partnership
- Need help with your business expenses
- Want to buy new assets for your business
- Think you’ve undertaken some research or development activity
- Employ individuals or are considering hiring your first employees
- Have annual turnover close to the VAT registration threshold
- Provide services predominantly to VAT-registered businesses
For information of users: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.
