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Once you’ve set up an incorporated business and become a director, you have to be smart about how you extract profit to avoid paying more tax than you need to. 

There are three main routes for a director to extract profits from their own limited company – salary, dividends and pension contributions. Usually, combining these three methods is the most tax-efficient approach to minimise your tax bill.

With corporation tax applying (at 19% in 2021/22) on any of your company’s taxable profits from its accounting period, the money you take out of the profits to pay yourself can potentially reduce your company’s corporation tax liability. 

Pay yourself a small salary

When running a limited company, it might be easy to overlook that your business’s money doesn’t go straight into your personal bank account. 

So, to get it into your pockets, consider paying yourself a basic salary. This is usually set just below certain thresholds for National Insurance contributions (NICs) with the aim of enjoying the benefits of paying NIC without actually suffering any. 

If, for example, you pay yourself more than the lower-earning limit (£6,240 in 2021/22), you will accrue qualifying years towards your state pension. 

While that’s a positive, paying yourself more than the Class 1 NICs secondary threshold (£8,840) would be a negative. 

Your company will become liable for employers’ NICs at a rate of 13.8% on any earnings above that. If you pay yourself a penny less than £8,840 in 2021/22, your company avoids paying this jobs tax altogether. 

The next payroll consideration is the personal allowance (£12,570 in 2021/22). The basic rate of income tax doesn’t apply until you exceed this threshold. 

One other pertinent point to consider is that any salary you pay yourself will be treated as a business expense, which means it will reduce your taxable profit and lower the amount of corporation tax your company has to pay. 

Taking dividends 

Dividends are paid to an incorporated company’s shareholders out of post-corporation tax profits. Usually, a director will be one of those shareholders and quite often the sole shareholder.

Many directors pay themselves in a combination of salary and dividends. As dividends are drawn from profit, you need to show you have profit reserves available before issuing dividends. 

If you cannot demonstrate that, HMRC could reclassify your dividends as salary and you would almost certainly need to pay income tax and NICs on that. 

Dividends are a different form of taxable income, and they are treated slightly differently in comparison to salary. The same income tax bands apply, but different dividend tax rates are associated with them. 

The best way to illustrate how dividends are taxed is through an example. Let’s say you’re the sole shareholder, your company has made post-tax profits of £29,570, and your accounting period runs parallel to the tax year. 

You take £8,000 as salary in 2021/22 and £29,570 in dividends, £37,750 in total. The £2,000 dividend allowance makes £27,570 of your dividend potentially taxable, while what’s left (£35,570) will exceed the personal allowance (£12,570). 

Once the personal allowance is deducted, £23,000 of your dividends will be taxable at 7.5%. You will fall into the basic-rate income tax band. This would leave you with a tax bill of £1,725, with the dividend being taxed as the top slice of income.  

Pension contributions

The single most tax-efficient way to extract profits from your company, but not the most practical, is to make employer contributions towards your pension pot. 

These will reduce the company’s liability to corporation tax and they are not subject to NICs, although this does involve taking money out of the company for future use.

You can potentially put up to £40,000 gross into your pension pot over the course of the tax year with no tax due. If you haven’t used any of your annual pension allowance over the last three tax years, you might be able to carry over any unused annual allowance from those years.

The total amount you can save without incurring charges into your pension pot is currently capped at £1,073,100, due to what’s known as the ‘lifetime limit’. 

Assuming you stay under these thresholds, when the time comes to take your pension benefits – currently after the age of 55, but rising to 57 from April 2028 – 25% is normally tax-free. 

The rest of your retirement income that exceeds the personal allowance will be taxed at your marginal rate of income tax under the existing rules. 

However you go about extracting profits from your incorporated business, getting personal tax planning advice will always help you pay the least amount of tax legally possible. 

Other tax-efficient tips

The main rate of UK corporation tax applies at 19% on your company’s profits, so the goal is to reduce those profits as much as you can before being assessed. 

The easiest way to reduce your company’s corporation tax bill is to claim every business expense you’re entitled to. The general rule is these must be “wholly and exclusively” used for business purposes, though. 

From stationery and phone bills to computer software and travel costs, there’s a long list of business expenses which you might be eligible for. You can claim for expenses with a dual purpose for business and personal use in certain circumstances as well. 

The golden rule is to keep accurate records of these expenses if you want to claim tax relief on those costs to reduce your company’s year-end profits. 

Taking advantage of the annual investment allowance is also a wise idea. This is currently set at £1m until 31 March 2023. This allowance lets your company deduct investments in plant and machinery – such as certain commercial vehicles, machinery and office equipment – from taxable profit in full.

For example, if your company has profits of £500,000 and you spent £250,000 on plant and machinery before 31 March 2023, the full amount can be deducted from your profits. This means only the £250,000 left would potentially be liable for corporation tax. 

Finally, if you’re in a position to pay your corporation tax bill early without harming the company’s cashflow, HMRC will pay you interest. 

You have nine months and one day after your company’s year-end to settle your corporation tax liability. But if you pay your tax six months and 13 days after the start of your accounting period, the tax authority will pay ‘credit interest’ back at 0.5% from the date you paid until it was due. 

For example, your company’s accounting period runs alongside the tax year from 6 April 2021 to 5 April 2022. You can make an early payment any time between 19 October 2021 and 6 January 2023 and earn interest. 

This interest would need to be included in your company accounts as it is taxable. 

Bear in mind that the UK’s main rate of corporation tax will increase from 19% to 25% from 1 April 2023, so getting used to extracting profits now will be time well spent. 

Speak to us for corporate tax planning advice.

If you’re looking to join the 4.3 million people in the UK who made the jump into self-employment, you might be wondering how to start your new business. 

Assuming you’ve weighed up the pros and cons involved and decided launching a startup is right for you, one of the first things to consider is how will you pay tax?

This requires you to choose a structure for your new business. The three most popular options are sole proprietorship, general partnership or limited company. 

Last year, operating as a sole trader was the most common structure as around 3.2m sole traders accounted for 56% of the UK’s entire private-sector business population. 

By comparison, there were 2m actively-trading companies and 384,000 general partnerships, making up 37% and 7% of the business population, respectively. You can also be a limited liability partnership. 

The vast majority of those sole proprietors are genuine one-man bands; that’s to say they don’t have any employees (in an official capacity, at least).

There’s no rhyme or reason for going it alone and it’s worth being aware of the key options on the table when you start a business. You can also change your business’s structure whenever you like, although that can prove costly.

HMRC issues last reminder for 2020/21 personal tax returns 

Some 407,510 startups were created during the 2020/21 tax year, despite the challenges presented by the pandemic. 

Those who are unincorporated require a unique taxpayer (UTR) code to file their first tax returns via self-assessment for the 2020/21 tax year.

But the tax authority is experiencing long delays in processing requests for the 10-digit UTR codes, according to The Times.

Taxpayers usually get these within 10 days of signing up for self-assessment, the deadline for which is 5 October. 

If they have not received their UTR code by 31 January 2022, they will not incur an instant £100 late-filing penalty for missing that self-assessment registration deadline.

The construction industry remains one of the UK’s key sectors, which also helps to underpin the UK economy, despite experiencing the effects of the COVID-19 pandemic. 

In September 2021, construction output grew by 1.3% on the previous month – placing the sector just 1% below its pre-pandemic level – and it’s still worth a decent share of UK GDP. 

Despite this monthly fluctuation, the Government remains committed to delivering up to 300,000 new homes a year by the mid-2020s.

Major infrastructure projects like the HS2 railway line and Hinkley Point nuclear power station in Somerset are also edging closer to completion.

It’s easy to see how the sector employs “more than 9% of the UK’s total workforce”, roughly equating to around 3.1 million people. 

Many of these will be familiar with the complexities of the construction industry scheme (CIS), which sets out rules for how payments to subcontractors for construction work must be handled by contractors in the industry, taking into account the subcontractor’s tax status.

From a tax perspective, there have been recent changes announced in the last 12 months which affect both the CIS and UK VAT. Not that many would know, given the lack of publicity. 

Who does the CIS affect?

Under the CIS, all payments made from contractors to subcontractors must take account of the subcontractor’s tax status as determined by HMRC. 

This may require the contractor to make a deduction, which they then pay to HMRC, from that part of the payment that does not represent the cost of materials incurred by the subcontractor.

The CIS covers all construction work carried out in the UK, including site preparation, alterations, dismantling, construction, repairs, decorating, and demolition.

Any type of domestic or overseas construction business – companies, partnerships, and sole traders – working in the UK must register for the CIS, regardless of whether they’re a contractor or subcontractor.  

Contractors & subcontractors

‘Contractors’ and ‘subcontractors’ have special meanings that cover more than is generally referred to as ‘construction’.

A contractor is a business or other concern that pays subcontractors for construction work. They might be construction companies or building firms, but may also be government departments, local authorities and many other businesses that are normally known in the industry as ‘clients’.

If a business or other concern spends more than £3 million on construction within the previous 12 months, they will be treated as a ‘deemed contractor’ and must monitor their construction spend regularly. Conversely, a subcontractor is simply a business that carries out construction work for a contractor.

In some cases, it’s possible for a business to be both contractor and subcontractor. This occurs when a business pays another firm for construction work, but also receives payment from another business.

When they’re working as a contractor, they must follow the CIS rules for contractors and when they’re working as a subcontractor, they must follow the rules for subcontractors.

How the CIS works

All contractors and subcontractors should register with HMRC for the CIS. Subcontractors will be subject to a higher-rate deduction if they have not registered.

Contractors deduct money from a subcontractor’s payments and pass it to HMRC. These deductions count as advance payments towards income tax and National Insurance, similar to PAYE.

A limited company will have deductions taken by the contractor from the income due to the company. 

This deduction can then be offset against other company tax liabilities such as PAYE, VAT, corporation tax or can be refunded to the company after the end of the tax year.

Sole traders and partnerships will also have deductions made from the income they receive. 

They are then required to report their gross income on their self-assessment tax returns, with contractor deductions also reported on the tax return and subsequently deducted from any income tax liability which is calculated as being due.

Contractors need to verify a subcontractor’s status with HMRC before payment is made to establish whether they are registered and the correct amount of tax to withhold. Tax can be deducted at source at 0%, 20% or 30%.

Contractors must report all of the payments they have made under the CIS to the tax authority, or report they have made no payments in the tax month, by the 19th of each month. 

Penalties apply if the monthly return deadline is missed.

Recent changes to the CIS

Four new measures affecting the CIS came in for 2021/22, which aim to crack down on tackling labour fraud. An obvious example is where a contractor pays casual workers cash-in-hand.

First, HMRC can amend the CIS deductions suffered and reclaimed on real-time information via the employment payment summary to an amount matching any evidence it holds. 

If there is no evidence, or a construction firm is not entitled to set-off in this way, HMRC can remove the claim completely and prevent you from submitting another set-off claim for the rest of a tax year. 

Being on the wrong side of this change could cause significant cashflow disruption and detailed records should be kept to support any set-off claims.

The second change is aimed at subcontractors who claim the cost of materials on a project, and avoid a CIS deduction on this amount as a result. 

It is only where a subcontractor directly incurs the cost of materials bought to fulfil a particular building contract that the cost in question is not subject to a CIS deduction.

Under CIS rules, contractors must ascertain both how much was spent and that it represents the direct cost to that subcontractor for the contract.

The third change updates the rules for operating CIS as a deemed contractor. 

Businesses operating outside the construction sector need to apply the CIS when their total spending on construction operations exceeds £3 million over the past 12 rolling months. 

Previously, a business only had to operate under the CIS if its average expenditure on construction operations exceeded £1m over the last three tax years. 

Last but not least, HMRC has expanded the scope for imposing a penalty for supplying false information on payment applications under deduction or gross payment status. 

The person or business to whom the registration applied could be penalised before last month, but now this also applies to anyone who exercises influence or control over a person registering for the CIS and either encourages that person to make a false statement or does so themselves.

The effects of reverse charge VAT

The VAT domestic reverse charge for building and construction services finally took effect on 1 March 2021. 

It affects VAT-registered businesses, typically those who either take on contracts or subcontract others within a supply chain, that operate under the CIS. 

Companies in the construction supply chain no longer receive their 20% VAT payment when they submit bills. Instead, the VAT is paid directly to HMRC by the ‘customer’ receiving the service.

The change is causing cashflow shortages for VAT-registered contractors, some of whom are owed repayments from HMRC at the end of each quarter dating as far back as last spring.

The tax authority said verification checks are slowing up the process, with some cases taking 30 days or longer while it waits for customers to supply the information required to verify the VAT return.

We can advise on the CIS.

Making Tax Digital for income tax (MTD for ITSA) looks certain to affect sole traders and landlords from April 2024, following the recent news of a one-year delay. 

This was the latest in a long line of delays and deferrals in the rollout of MTD, which was first proposed by then-Chancellor George Osborne in late 2015. 

Small businesses were originally due to be the first to go through MTD in April 2018, at which point the focus switched to MTD for VAT. MTD for ITSA was to be delayed until lessons had been learnt from the VAT rollout.

MTD for VAT started on time for most of the UK’s VAT-registered businesses with VAT periods starting on or after 1 April 2019, although “complex” entities had a deferred start date to 1 October 2019. 

A similar deferral is in place for general business partnerships, with these “ordinary partnerships” due to enter MTD for ITSA from April 2025.

At the time of writing, there’s no indication of when other more complex partnerships will have to join MTD, and we don’t know if MTD for corporation tax will start as planned from April 2026.

Sole traders & landlords

Shortly after MTD for ITSA was delayed on 23 September 2021, legislation was publicised to confirm the regime will come into effect from April 2024. 

Specifically, this will affect sole traders and unincorporated landlords with business or property income of £10,000 or more starting in the 2024/25 tax year.

The £10,000 threshold applies to gross income or turnover, not profit. Where the individual or entity has more than one trade or property business, the figures are combined in determining if the threshold has been breached. 

For example, if a taxpayer has £9,000 of rental income and £9,000 of sales from a sole trader or partnership business, their gross income will be £18,000 – £8,000 over the threshold – and they will be in scope of MTD for ITSA.

General partnerships

For general partnerships with income above £10,000, MTD for ITSA now starts in the tax year beginning 6 April 2025. 

Previously, it had been expected to start at the same time as the general MTD for ITSA scheme in April 2023. 

Other types of more complex partnerships, such as limited liability partnerships, mixed or corporate partnerships, will follow at an as yet undisclosed time.

The requirements and filing deadlines which will apply to general business partnerships will be the same as those that are mandatory for sole traders and landlords a year earlier.

Exemptions

The same exemption criteria that applies to MTD for VAT will apply to MTD for ITSA. That means the following are all exempt:

• non-resident companies
• trustees, executors and administrators
• businesses that are subject to an insolvency procedure
• foreign businesses of non-UK domiciled individuals. 

Businesses that are run entirely by practising members of a religious society or order whose beliefs are incompatible with using electronic communications or keeping electronic records are also exempt. 

As are instances where it’s not practicable for sole traders or partners to use digital tools to keep their business records or submit quarterly returns due to age, disability, or remoteness of location.

If any of the above apply, you must apply to HMRC in writing or over the phone to claim an exemption. You can do this now if you wish, and the tax authority will either grant or deny the application within 28 days.

Software & filing deadlines

From 6 April 2024, those affected must use MTD-compliant digital software to submit quarterly summaries of their business’s income and expenses.

The software you use will generate updates and statements for you, while the Treasury hopes to offer free software products to businesses with straightforward tax affairs. 

The quarterly deadlines for most unincorporated businesses filing under MTD for ITSA will be on or before:

• 5 August (for period 6 April – 5 July)
• 5 November (for period 6 July – 5 October)
• 5 February (for period 6 October – 5 January)
• 5 May (for period 6 January – 5 April).

In return, unincorporated businesses will receive a tax estimate from HMRC based on the details provided in the quarterly summaries. This should provide a more real-time picture of a business’s tax liability. 

The 31 January income tax payment deadline will remain in place, and this will also be the deadline to send an end-of-period statement following the relevant tax year. 

This will mean the self-assessment tax return will become a thing of the past. As it stands, 2023/24 tax returns will be the last to be filed through self-assessment on or before midnight on 31 January 2025. 

Penalties regime

A new late-submission penalties regime will come into effect for MTD for ITSA from April 2024. This will be the same points-based regime that’s being introduced to MTD for VAT from 1 April 2022. Unlike the late Bruce Forsyth used to say, these points definitely do not “win prizes”. 

From 6 April 2024, a sole trader or landlord will receive one point for each submission deadline they miss. When the business reaches a certain points threshold, a £200 fixed penalty will apply for that return and any subsequent late returns. 

The penalty thresholds are as follows:

Submission frequency	Points threshold
Annually	2
Quarterly	4

The points expire two years after the month in which the fine was issued if you file annually, as long as you meet all your obligations and have made all the submissions due within the last 24 months. If you file quarterly, a compliance period of 12 months applies instead. 

What you can do to prepare

So, sole traders and landlords have little more than two years to implement MTD-approved software within their business and the good news is there are plenty of options on the market to get started now. 

Broadly speaking, there are three different types of software to help your business comply with MTD for ITSA, including the most popular option – software packages. These include, but are not limited to, Xero, QuickBooks and Sage. 

Then there’s API-enabled spreadsheets, which have an in-built function that enables them to file returns via HMRC’s API server, and bridging software which takes information from an existing spreadsheet and submits it to HMRC.

Given that MTD is here to stay, pick a software package that suits your long-term needs and offers multiple benefits.

Taking a digital approach to manage your business’s finances will give you a real-time cashflow position, which enables you to make better-informed decisions. 

Using cloud accounting software also promotes collaboration with us as your accountant, reducing chances for errors and keeping you on the right side of HMRC. 

Software products let you access your business accounting anytime you want, meaning you can spot problems like late payments and take action to resolve it. 

Useful reports and dashboards also give you insights into your business, such as why your business seems to do well at a certain time of the year or how certain customers provide most of your income.

Speak to us about MTD for income tax.

Reforms to the ways in which unincorporated businesses pay income tax – known as basis periods – will go ahead, one year later than planned. 

Proposals and draft legislation were published in July 2021, suggesting the new rules would commence from 6 April 2023. 

Instead, sole traders and most business partnerships will be subject to income tax on profits arising in a given tax year from 6 April 2024. 

This will mean no change for self-employed businesses with an accounting year-end between 31 March and 5 April. 

But for other businesses, this is likely to bring forward the date on which taxable income will need to be calculated and tax will need to be paid.

This new method of calculating taxable profit will apply from the 2024/25 tax year, rather than 2023/24 as previously planned.