As a Sole trader, Partnership, or Limited liability partnership you pay tax through the self-assessment tax regime. Tax payments are required to be made in two equal instalments on 31 January and 31 July each year.
A tax year runs from 6 April each year and ends on 5 April and income for this period is reported on an individual’s personal income tax return.
So for the tax year 2015/16, you would ordinarily pay half your tax on 31 January 2016 and then the other half on 31 July 2016.
How can this be you might ask?
How can I pay half my tax for 2015/16 on 31 January 2016, as the tax year does not end until after that date – the 2015/16 tax year ends on 5 April 2016!
Well, HMRC require you to make payments on account of your current year’s tax liability based on your total self-assessment income tax liability for the previous year. So for 2015/16, you would make two equal payments on account of this year’s tax liability but these would be set based on your overall tax liability for the previous year, 2014/15. When you have completed your tax return for the year 2015/16 and determined your actual liability you will be required to pay any balance, or HMRC will issue you with a refund if you have paid too much tax, and this will happen on 31 January 2017.
All pretty confusing!
So why do some people think you don’t pay tax on the first year's profits? Well, that is because you may not physically pay the tax until well over a year of starting your business, but you will still pay tax on the first years profits at some point, so be aware.
To give an example:
Let’s say Mr Blogs starts his business on 15 April 2015. His first accounts and income tax return will be made up to 5 April 2016, the tax year 2015/16.
Ordinarily. for the tax year 2015/16, he would make payments on account based on his previous year’s liability on 31 January and 31 July 2016. However, as this is his first year he does not have a previous years self-assessment tax liability and HMRC would have no idea of what level to set the payments on account at. As a result, they do not request that he makes any.
Instead, Mr Blogs will pay all of his 2015/16 income tax liability on 31 January 2017, when he is required to have filed his personal tax return for the year 2015/16. In addition this liability will trigger payments on account for the next tax year 2016/17 and the first instalment for this year will also be due on 31 January 2017, meaning he will have 18 months of tax to pay on that day!
So whilst Mr Blogs starts his business on 15 April 2015 he does not pay any tax for almost 21 months. The first tax payment is due on 31 January 2017 but this is going to be a big payment of 18 months of tax in one go.
So don’t be confused or misled into thinking your first years profits are tax free. They are not and you need to set aside money for your tax from the outset of starting your business.
Things are simpler in terms of the rules for tax payments for Companies. They pay Corporation tax and the whole amount is paid in one go 9 months after their year-end.
Rules for tax payments are complicated, so ensure you seek professional advice if you are unsure of what you need to do.