As an entrepreneur, running a small business in the U.K. is challenging enough without the merry-go-round of having to manage taxes. Yes, you want to pay your fair share of tax, but at the same time, you also want to maximise your profits and cash flow. But how can you achieve both goals without getting into trouble with HMRC?
The answer is tax optimisation – an intricate process of planning and implementing strategies to reduce your tax liability.
Before we move forward, you should note that tax optimisation is not the same as tax evasion, which is illegal and can result in legal penalties. Tax optimisation is a legitimate and smart way to save money to boost your business’s financial health.
Now, let’s explore some of the most effective tax optimisation strategies for small businesses in the U.K.
Effective Tax Optimisation Strategies
- Choose The Right Business Structure
One of the first decisions you need to make as a small business owner is how to structure your business, as this will influence how much tax you pay, how you report your income, and your business obligations.
In the U.K., there are four main types of business structures: sole trader, partnership, limited company, and limited liability partnership (LLP).
Each business structure has its pros and cons, but generally, sole traders and partnerships have more flexibility and lower administrative costs. However, they also have more personal liability and less tax efficiency.
Even though limited companies and LLPs face higher administrative costs and stricter regulations, on the upside, the business model presents better tax optimisation opportunities, and company owners face less personal liability.
- Claim All Allowable Expenses
One of the easiest ways to limit your liable tax is by claiming all business-related allowable expenses. It would help to deduct these expenses from your income before calculating your taxable profit so you only pay tax on gross profit. Some examples of allowable expenses include:
- Office costs: rent, utilities, stationery, phone, internet,
- Travel expenses: fuel, parking, train fares, etc.
- Clothing costs: uniforms, protective gear, etc.
- Employee allowances: salaries, wages, pensions, etc.
- Marketing costs: advertising, website design, etc.
- Legal and financial fees include insurance, bank, accounting, etc.
In order for you to claim allowable expenses without hitch, you need to keep accurate records of your income and expenditure, as well as receipts and invoices for all your purchases in the event of an audit by HMRC.
- Take Advantage of Tax Reliefs and Allowances
Many entrepreneurs are oblivious to the various tax reliefs and allowances the government makes available to small businesses. Don’t make this mistake. Per HMRC, as a small business owner, you’re eligible for the following tax breaks:
- Annual Investment Allowance (AIA): Annual investment allowance benefits your business by granting you leeway to deduct the full cost of a business item such as computers, equipment, or vehicles in the year of purchase. However, this allowance comes with a caveat: the expenditure has to qualify as business expenditure. Also, as of April 1st 2023, the current AIA limit is £1 million per year. Hence, any sum above this will have to be carried to the following tax year.
- Capital Allowances: Capital allowance is a deductible percentage of the cost of certain business assets, such as buildings, fixtures, and furniture, from your income over several years.
- Research and Development (R&D) Tax Relief: R&D relief is a claimable tax deduction of up to 230% on your total R&D costs, such as staff wages, materials, and software. However, to qualify for R&D tax relief, you must demonstrate that your project is innovative, scientific, or technological and aims to overcome uncertainty in a challenging field.
- Patent Box: To qualify for the patent box, you need to prove you have made a significant contribution to developing or applying a patent or intellectual property right. If your business qualifies for this relief, you pay a lower rate of corporation tax (10%) on your profits from patented inventions and certain intellectual property rights.
- Utilise Pension Contributions and Dividends
A significant benefit of being a small business owner is that you have more control over how you pay yourself, so you can utilise pension contributions and dividends in optimising how you pay personal tax and national insurance. Let’s briefly examine both methods;
Pension contributions are payments you make into a pension scheme to save for retirement. A major reason why pension contributions are tax-efficient is because they reduce your taxable income and your national insurance. However, the current annual allowance for pension contributions is £40,000 per year or 100% of your relevant earnings, whichever is lower, so it can only go so far in minimising your tax.
Conversely, dividends are payments you receive from your company or LLP as a shareholder. Dividends are tax-efficient because they are not subject to national insurance and have lower income tax rates than your typical salary. The current dividend allowance is £2,000 per year, meaning you can receive up to £2,000 of dividends tax-free. Any dividends above this amount are taxed at your income tax band rate.
Tax optimisation is an essential part of any entrepreneurial endeavour. By following the strategies outlined in this article, you can reduce your tax liability while staying within the confines of the law. Alternatively, you may hire an accountant to save you time and ensure you pay the right amount of tax to avoid HMRC penalties, allowing you to focus on the day-to-day aspects of your business.
Looking for an accountant in London? Sloane Winckless are veritable accountants Epsom entrepreneurs have relied on for tax advice and accounting audits for decades.