7 Tax Efficiency Tips for Small Businesses

Working as self-employed or through a limited company

If you are self-employed and your business is growing, then you might be considering making the jump to working through your own limited company. A limited company is a completely separate legal entity and the question of whether this move would be worthwhile is dependent on numerous factors. However, for many successful self-employed businesses a change of status to a limited company offers a multitude of important benefits. This can include considerable tax savings under the right circumstances.

Business Asset Disposal Relief

If your limited company is sold there can be significant tax benefits. For example, when you sell qualifying shares in a trading company you may be able to claim Business Asset Disposal Relief (BADR), previously known as Entrepreneurs’ Relief. This means that you would only have to pay 10% CGT rather than the normal rate of 20% on the first £1 million of capital gains.

BADR applies to the sale of a business, shares in a trading company or an individual’s interest in a trading partnership. There are a number of qualifying conditions that must be met in order to qualify for the relief.

Claiming business expenses

The rules for deciding what business expenses can be deducted from profit for tax purposes are similar whether you trade through a limited company or as a sole trader or partnership. The importance of claiming all your allowable business expense deductions can make a significant difference to your tax bill.

For a limited company, the general rule is that expenses must be “wholly, exclusively and necessarily” incurred for the job. Whilst for the self-employed, the rule is that any expenses must be “wholly and exclusively” for business purposes.

Carry back a company trading loss

Corporation Tax relief may be available where a company makes a trading loss. A qualifying trading loss may be used to claim relief from Corporation Tax by offsetting the loss against profits in previous years.

This could be an especially useful option for the many companies that have been hard hit during the pandemic and may have incurred significant losses. Carrying back a trading loss allows companies to seek relief for the losses by carrying them back to an earlier profit-making period resulting in a reclaim of Corporation Tax.

In exceptional cases, HMRC will allow claims to be carried back based on anticipated losses before the end of a current accounting period.

Extracting profit from your company

Small business owners should always be looking at ensuring they are paying themselves in the most tax efficient way. There are also other profit extraction options that should be considered such as paying interest on any funds directors may have loaned their company and using, or re-examining, tax-free benefits.

For example, making pension contributions is very tax efficient as long as it falls below the current annual allowance limit of £40,000 for tax free contributions. However, directors will need to wait until they are at least 55 to access this money.

Staff parties

The cost of a staff party or other annual entertainment is generally allowed as a deduction for tax purposes. If you meet the various criteria, then there is no requirement to report anything to HMRC or pay tax and National Insurance. There will also be no taxable benefit charged to employees. Note the average cost per head of the function cannot exceed £150 and the event must be open to all employees. There can be more than one annual event and if the total cost of these parties is under £150 per head, there will be no chargeable benefit.

The VAT flat rate scheme

The purpose of this VAT scheme is to simplify the way a business accounts for VAT and so reduce the cost of complying with their VAT obligations. However, businesses most often make decisions based on cold hard cash and most businesses that sign up for the flat rate scheme do so in order to save money on their VAT bill.  The scheme is especially useful for businesses with minimal VAT on business expenses (input tax) to reclaim.

Businesses can only apply to use the flat rate scheme if they expect their annual taxable turnover in the next 12 months to be no more than £150,000, excluding VAT. Using the flat rate scheme, a business simply pays VAT as a fixed percentage of their total VAT inclusive turnover. The actual percentage depends on the type of business. There is also a further 1% discount in the first year of using the scheme.