Back to Tax Basics: Tax for unincorporated businesses
You don’t have to be a limited company to trade as a business. It’s possible that you’re operating already as an ‘unincorporated entity’ (usually as a sole trader, or a partnership). And the way that limited companies and unincorporated entities are taxed is very different.
Here's how tax works for unincorporated businesses and the things you need to consider when it comes to your tax planning.
A different way of paying your business taxes
If you operate your business through a limited company, the company itself will pay corporation tax on its profits – and, as a director, you’ll generally be paid through a mixture of salary and dividends.
If you operate an unincorporated business, e.g. as a sole trader, you won’t pay corporation tax, but you will pay personal tax and National Insurance on any business profits you’ve made.
- In most cases, the taxable profits are calculated in a similar way whether you’re trading through a limited company or as a sole trader. As a sole trader you can’t claim wages for yourself as a business expense, although you can employ other people.
- The next main difference is the use of a private vehicle for business. Because there’s no legal difference between you as an individual and your sole trader business, your vehicle doesn’t count as a company car.
- You can recover the business use of your personal vehicle by charging the HMRC-approved mileage rate (£0.45/mile for the first 10,000 miles in the tax year, £0.25/mile thereafter). Or you can claim the business proportion of your vehicle costs (fuel, servicing, repairs, insurance, vehicle tax etc) together with the appropriate proportion of capital allowances to cover the initial purchase price.
- Again, because there’s no legal difference between the individual and the business, pension contributions will be ‘personal’ rather than ‘company’ contributions. Although there is tax relief available, the contributions don’t come off the business profits and the tax benefits aren’t as attractive as they can be for company directors.
- Capital allowances are claimed in a similar way to the limited company calculations, although the super-deduction capital allowance is only available to limited companies.
- There are some differences in the way that ‘home office’ type costs are calculated, but these aren’t likely to be significant.
Changes to the basis period for your accounting
Limited companies can choose any trading year they like and are taxed for that period. Although sole traders can make their own choice of year-end, they’re always taxed on a tax year to 5 April each year. Most unincorporated businesses have a 5 April (or 31 March – considered to be the same for most purposes) accounting period end, but some use other dates such as 31 December each year.
Unincorporated businesses are currently taxed on the profits of the business year that ends in the tax year. So, a business year ended on 31/12/2020 will be taxed as if the profit related to the tax year ended 5 April 2021. And profits in the business year to 31/12/2021 will be treated as if they covered the tax year to 5 April 2022. (NOTE: there are specific rules covering the first and last couple of years of trading but we won’t go into the details of this here.)
The way unincorporated businesses are taxed will change from 6 April 2024:
- All businesses without a 31 March to 5 April accounting period-end will see their profits allocated to the tax year based on calendar days. The year to 5 April 2024 will be a transitional year.
- With the 31 December business, profit for the year to 31/12/2022 will all be taxed in the tax year to 5 April 2023 as now. In the 2023/24 year, all profits for the business year to 31/12/23 will be included, PLUS profits from 01/01/2024 to 05/04/2024 calculated from the 31/12/2024 – so effectively about 15 months of profits.
- The 2024/25 tax year will include prorated profits from 6 April 2024 to 31 December 2024 from the 31/12/2024 accounts plus profits from 1 January 2024 to 5 April 2025 calculated from the following year’s accounts.
- The 2023/24 tax year can be a problem. Because it includes more than a year’s profits, the tax won’t only go up proportionally, but may also push you into higher tax brackets and for some, may result in things like Higher Income Child Benefit Charge artificially being triggered. If, rather than a December year end, a business operates with a June year end, that year will include 21 months’ profits.
- HM Revenue & Customs (HMRC) has indicated that any additional tax may be spread over a number of years to ease some of the pressure. But, even with this measure, tax payments will be accelerated.
Paying your income tax on business profits
When your business taxable profits are calculated, they’ll be subject to income tax. Your annual tax-free personal allowance (currently £12,570) is deducted, and the rest taxed at the basic, higher and additional rates as appropriate. Tax relief on things like your personal pension contributions and gift-aided charitable donations may be available to reduce your overall tax bill.
Other things to note include:
- You’ll generally pay two types of National Insurance contributions (NICs) – a flat rate Class 2 contribution of £158.60 for 2021/22 plus Class 4 contributions at a rate of 9% for annual profit between £9,568 and £50,270. Then a higher rate of 2% that will be charged on profits above that level.
- Remember that all sources of personal income are brought together on your personal tax return, and an overall tax liability calculated. This can include, for example, profit from self-employment, rental income for any residential and furnished holiday lets you may have, paid employment that has been subject to PAYE and other sources such as dividend and interest income.
Talk to us about your tax planning
If you’re an unincorporated business and need to get your tax planning under control, please do come and talk to us. We can help you get your compliance in order, complete your self-assessment income tax return and apply for any tax reliefs that are available.
Working for yourself - https://www.gov.uk/working-for-yourself
Running a business from home - https://www.gov.uk/run-business-from-home
Set up as a sole trader - https://www.gov.uk/set-up-sole-trader
Business Records if you’re Self- Employed - https://www.gov.uk/self-employed-records
Keeping your pay and tax records - https://www.gov.uk/keeping-your-pay-tax-records
Expenses if you're self-employed - https://www.gov.uk/expenses-if-youre-self-employed
Simplified expenses if you're self-employed - https://www.gov.uk/simpler-income-tax-simplified-expenses
Claim capital allowances - https://www.gov.uk/capital-allowances
National Insurance - https://www.gov.uk/national-insurance
Cash basis - https://www.gov.uk/simpler-income-tax-cash-basis