A Guide to Tax and National Insurance for New Entrepreneurs

Tax and National Insurance are two topics new entrepreneurs must understand from the beginning of a business venture. The following is a brief guide to the basic issues.

Income Tax

The law obliges all self-employed entrepreneurs to fill in a self assessment tax return every year. HM Revenue & Customs (HMRC) uses the net profits shown on the return to calculate the level of income tax.

Entrepreneurs who are directors of limited companies are employees. Hence they pay income tax and National Insurance under the Pay As You Earn (PAYE) scheme. A business makes these payments to HMRC on behalf of the directors.

Despite their PAYE status, company directors also complete a self assessment tax return. Directors should use the return to declare taxable benefits, and to claim allowances and reliefs. Taxable benefits include company cars. Allowances and reliefs include the income tax personal allowance, and relief on contributions made to pension schemes. The self assessment return comes with a separate guide that explains benefits, allowances, and reliefs in detail.

In a business partnership, one of the entrepreneurs must complete a tax return for the business. The return provides HMRC with information about the profit made by the partnership, and the percentage taken by each partner. Entrepreneurs who are partners in a business must also complete individual self assessment tax returns.

National Insurance

Employees (directors of companies) pay Class 1 National Insurance contributions from their salaries under the PAYE scheme. An employer (that is, the business of which an entrepreneur is a director) pays Class 1 secondary contributions each month, and Class 1A contributions annually for each director. The latter apply to benefits in kind such as private medical insurance and a company car.

Self-employed entrepreneurs pay Class 2 National Insurance contributions monthly or quarterly at a set national rate. In addition, the self-employed pay Class 4 contributions annually. HMRC calculates the level of Class 4 contributions using the self assessment tax return, and requests payment with income tax.

Class 3 contributions are flat rate voluntary payments. The only people who need pay Class 3 are those who have not made sufficient National Insurance contributions to qualify for state benefits.

An entrepreneur in a business partnership pays Class 4 National Insurance contributions on his or her share of the profit.

Tax and National Insurance Deadlines

• A tax year runs from 6 April to 5 April.
• 31 January is the deadline for tax returns from the previous tax year.
• Entrepreneurs who complete paper tax returns, and who want HMRC to calculate income tax and Class 4 National Insurance, must submit the paperwork by 31 October following the relevant tax year.
• HMRC cannot guarantee to provide entrepreneurs with details of tax and Class 4 National Insurance liabilities before 31 January if paperwork arrives after 31 October.
• The deadline for submitting online tax returns is 31 January following the tax year.
• Entrepreneurs who miss the 31 January deadline face penalties, plus interest on overdue tax.

VAT

An entrepreneur must register with HMRC to pay value added tax (VAT) if business turnover for the last 12 months exceeded a certain amount (currently £67.000). Registration is also necessary if it looks as though annual business turnover is about to be higher than the threshold figure. Even if business turnover is less than the threshold, an entrepreneur can register for VAT voluntarily.

In general terms, an entrepreneur registered for VAT adds the tax to business sales and reclaims it on business purchases. HMRC claims the difference when VAT on an entrepreneur's sales is greater than the VAT on purchases. When VAT on purchases is more than the VAT on sales, HMRC refunds the difference.

Entrepreneurs must send HMRC a VAT return every quarter.

Corporation Tax

An entrepreneur with a limited company is liable for corporation tax on the profits. He or she must complete a self assessment corporation tax return within twelve months of the end of the company’s accounting period, or within three months of receiving an HMRC request. Failure to do so incurs penalty charges.

An entrepreneur must pay corporation tax within nine months and one day of the end of the company accounting period (this is earlier than the date for filing the company tax return for the same period). Late payment attracts penalties.

In HMRC jargon, the tax return deadline is the “statutory filing date”; the payment deadline is the “normal due date”.

A company accounting period is not necessarily the same as the tax year. It may, for instance, run from 1 January to 31 December.