Your Business Community Logo

Call Us On 0333 358 3399

Join Now Button

Wednesday, 03 June 2015 08:43

The Myths Of First Year Profits

Written by
Many people starting up in business are under the false impression that they don’t pay tax on their first year's profits. I have heard this more times than I can count from people in the infancy of a business so I thought it would be good to set the record straight.

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.

Related items

  • Will HMRC Come After You?
    HMRC are under pressure from politicians who are demanding that they recover more unpaid tax even though they delivered a record haul of almost 30 billion pounds from their compliance activity during the last financial year.

    Despite popular opinion that some large companies ought to be targeted for their blatant tax avoidance, it appears that small business owners are more likely to be brought under the microscope. HMRC can opt to instigate criminal or civil investigations and the way in which business owners react initially often determines the way proceedings are handled. As a result, it is essential that expert advice is taken immediately.

    This expert advice would normally be sought from an accountant but the cost of defence can be extremely expensive. An investigation can be targeted or random and it is up to the business owner to prove their innocence. It is not uncommon for investigations to last for longer than a year and to cost several thousands of pounds in accountancy fees. This is without any additional tax that may be found owing.

    Insurance to pay accountancy fees in such circumstances is available but is costly because of both the volume of investigations and their length. Basically, on your own, you are a bad risk

    Members of Your Business Community (YBC) enjoy this protection as part of their membership and by joining you will become a good risk relatively speaking.

    We insure our cars and houses as routine so, for many, it is prudent to insure our businesses too.

  • Tax Investigation Is On The Increase
    Despite widespread media coverage of large companies blatant avoidance of paying tax, it is still the smallest of businesses coming under the microscope of HMRC.

    Surprisingly in the past sectors such as Barristers, Dentists and Doctors have come under investigation as well as the more expected areas such as Building and Motor related firms.

    However, with more and more people becoming self employed or running their own business, nobody is off limits for HMRC. Any additional tax found owing can be backdated and made worse by the addition of compound interest.

    A typical tax investigation lasts for around 17 months and costs around £5000 in accountancy fees to defend. Even without any extra tax to pay this is a hefty sum to pay to prove your innocence.

    Membership of Your Business Community (YBC) includes tax investigation insurance so that if your affairs come under examination your accountancy fees are paid for. It also provides Free Legal advice 24/7 and Free Tax advice during office hours

    We are often asked why isn’t our tax advice available 24/7 too and the answer is simple. If you need tax advice outside of office hours it is almost certain that you need to be speaking to a lawyer!

  • It's that time of year again
    Its that time of year where you need to start thinking about your investments and particularly your stock ISA, if you haven't already. Remember if you don't use it you lose it!

    It’s that ISA time of year again

    Last week I had a client come in to my office with over half a million pounds worth of share certificates that had been accumulated for over 30 years. What a logistical mess. It took my team over 7 hours to work through all of the papers and this is only the first part of the job done.

    Now the fun bit starts where we have to contact the various Share Registrars and raise indemnities to sort out missing or invalid certificates. I don’t know if you have ever tried calling a Share Registrar but you are typically on hold for around 10-15 minutes and because it’s a premium rate telephone number it can get expensive. The hold music is pretty bad too but that’s another story.

    However, it should really come as no surprise to me. This time of season is especially worse because we are fast approaching the end of the tax year. It’s the time that everybody seems to have awoken from their long winter hibernation. To describe it as a frenzy is not an understatement. It really is with everybody scrambling to get their paperwork in order to avoid paying HMRC huge tax bills.

    That’s why I am writing this article to share how a bit of forward planning can save you lots of time and money. Here are a few tips to consider.

     

    1. £20,000 ISA Allowance – if you don’t use your allowance you lose it and so you should always make sure that you take advantage of it if you can. Even if you don’t have the cash to put into an ISA, you should be considering moving shares that you hold in certificated or non-ISA form into your ISA.

     

    1. The ‘dividend allowance’ falls from £5,000 to £2,000 from April 2018 which means that if you are holding income paying shares outside of a tax wrapper you could get stung. The trick is put money into a SIPP and stock ISA. Or if you want to be really clever you can change income into capital! – watch today’s short video I show you exactly how to do this (link below).

     

    1. Don’t hold share certificates. Part of the problem of poor tax planning is not knowing which shares are doing well or badly and how much profit you are making. That’s why to hold your investments in a nominee (electronic) form (which is how 99% of the UK population prefers to hold their shares) makes sense. And don’t worry about attending AGMs, you can still do so just by letting your broker know.

     

    1. Change of strategy – with income being taxed much more aggressively than capital growth then it pays to move out of income paying stocks and into capital growth stocks. However, many investors don’t like the idea of this because they believe that capital growth stocks are higher risk than income. Watch today’s video of how to get around this.

     

    1. Lifetime ISA (LISA) – this is a great product which I’m surprised so few people know about. If you are aged between 18 and 40 you can invest up to £4,000 into a LISA and the Government will give you £1,000 for free which is a whopping 25%. There are some terms attached but nothing insurmountable.

     

    1. Cash ISA – there is still some confusion about cash ISAs so allow me to dispel them. Since 2014 Cash ISAs and Stocks and Shares ISAs are one and the same thing. That means that you can shift from cash to share investments and vice-versa relatively easily. With cash ISAs paying less than inflation it does make me wonder why investors may want to hold cash ISAs at all, but that’s another article for another time.

     

    1. SIPP is a great way to shield from IHT. If you have a normal pension you should consider getting tax advice on whether it makes sense to convert it into a SIPP. All pensions are exempt from Inheritance Tax but SIPPs give you greater control. If you are working then making pension contributions and earning higher rate tax relief on the way in and only paying basic rate tax on your drawdowns is one way that many savvy investors are really utilising this tax vehicle. However, like all products that prove popular with the public, don’t be surprised if the Government takes it away or changes the tax breaks before too long. (The Government has already reduced the life time allowance on more than one occasion so they could do it again.

     

    1. SIPP Lifetime Allowance – one big problem that investors sometimes face is being TOO successful. If they invest wisely and their SIPP value exceeds the lifetime allowance which currently stands at £1m, then they will get charged a whopping 55% on any withdrawals. Well the good news there is something that you can do about that. If you want to know more call our offices.

     

    Just so that you know I am not a tax advisor and I’m not giving tax advice. However, I do work very closely with a number of tax specialists who help my clients to achieve their objectives. Over the years I have picked up the tricks of the trade and found it to be easier than you might normally imagine. Understanding basic tax is essential to being successful in the long term and whilst it’s not a topic of great excitement it’s necessary so don’t hold it off until next year.

  • HMRC Vows To Crack Down On Use Of Freelance Jobs
    In relation to staff used for freelance jobs, a specialist HMRC team will target employers suspected of avoiding national insurance.

    HMRC has announced it is to form a specialist team to examine working practices at organisations that use staff for freelance jobs to fill what amount to full-time roles.

    Employers that persistently use office-based freelance workers to cover what would otherwise be full-time positions avoid offering individuals any of the associated benefits of full-time employment, such as sick pay, pensions and maternity leave, as well as avoiding employer national insurance contributions (NICs).

    If an organisation is found by HMRC to be in breach of existing laws, it could be fined up to 100% of the tax owed. The Treasury said it is currently owed more than £300m in lost national insurance contributions.

    It is unclear how widespread the practice is.  The crackdown comes at a time when HMRC is taking a renewed interest in the use of ‘umbrella companies’ to pay staff, and other unusual working arrangements that circumvent NICs and other taxes.

    Taxi-hailing app Uber and food delivery service Deliveroo are also legal cases over the status of their workers, who are currently classed as self-employed, with a tribunal decision on Uber’s case that has just come in as can be seen here:

    Uber's Employment Tribunal, on October 28th, ruled that two drivers who provide services to  Uber are 'workers' within the meaning of the Employment Rights Act 1996.

    This means they will be entitled to a limited number of employment rights .  Amongst other rights, they will be entitled to:-

    • 5.6 weeks' paid annual leave each year
    • a maximum 48 hour average working week, and rest breaks
    • the national minimum wage (and the national living wage)
    • protection of the whistleblowing legislation.

    As they are not employees, they will not be entitled to:-

    • the ability to claim unfair dismissal
    • the right to a statutory redundancy payment
    • the benefit of the implied term of trust and confidence
    • the protection of TUPE, if Uber sells its business

    I’m sure the verdict will be appealed and no doubt it is fact specific but be aware if you are taking on people under similar circumstances.

    Prime minister Theresa May recently announced a review of workers’ rights, amid concerns that almost half a million workers in the UK could be wrongly classed as self-employed. The review will look at whether the national living wage is being undermined, and what changes in legislation may need to be implemented as a result.

  • One Less Thing to Worry About: Advance Assurance For R&D Tax Relief
    You might've heard rumblings across the Research and Development landscape about the UK government's new Advance Assurance scheme for R&D claims. So, what's all the fuss about? Is the system going to have a real impact, or is it just another hoop to jump through? Let's take a look and see what it's all about.

    The idea itself is pretty solid, on the face of it. The government has finally noticed what we at RIFT have been saying for ages - that far too few businesses with big ideas are getting the R&D Tax Credits they're entitled to. With that in mind, they're trying to remove at least one of the obstacles keeping those businesses out: the worry about whether or not they'll be rejected, having put the time in to make a claim.

    Here's how it will work: if you're a smaller business looking to make your first R&D Tax Relief claim, you’ll be able to send some details about your business and projects to HMRC and they'll let you know if you qualify. If you do qualify, as long as you stick to the plan you outlined, they'll automatically approve your claims for the first three accounting periods, without asking any further questions. Honestly, it sounds pretty good, in principle.

    Of course, you still have to fit the profile they're targeting with the scheme. To qualify for Advance Assurance, your business can't:

    • Have claimed R&D Tax Relief before.
    • Have an annual turnover of more than £2 million.
    • Have 50 or more employees.

    There are a few other technical restrictions as well, but basically they've got their sights set firmly on newer and smaller businesses, or those who are flexing their R&D muscles for the first time. For the time being, at least, though, it seems you'll hit a few inevitable teething problems when you apply for Advance Assurance. For instance, you can only reply by post so far, as they don't have an online version of the form yet. RIFT work closely with HMRC, though, and we’ll be giving them lots of feedback on how they can improve the initial proposal to make it more supportive of small businesses.

    Once you've had your application accepted, you ought to get an answer within about three months. It's worth noting that a rejection at this point won’t mean you can't claim R&D Tax Credits at all for your projects. You can still make a claim through the normal channels. Also, those size restrictions listed above only apply at the point when you make your application. If your fledgling hits its growth spurt while you're still in the scheme, the change in your size won't affect your Advance Assurance.

    Overall, it's good to see the government making steps in the right direction, and anything that encourages businesses to consider R&D Tax Relief is good news in our books.

Login to post comments