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.
If you operate your business through a limited company, the company itself will pay corporation tax on its profits. As a director, you’ll generally be paid through a mixture of salary and dividends.
If you operate an unincorporated business, as a sole trader for example, you won’t pay corporation tax. However, 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. There’s no legal difference between you as an individual and your sole trader business, therefore 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. 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, there’s no legal difference between the individual and the business. This means 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. However, 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. To read more on home expenses, and what you can claim, read our article here.
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.
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. A higher rate of 2% will be charged on profits above that level.
All sources of personal income are brought together on your personal tax return, and an overall tax liability calculated. This can include: 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.
Please note, the way unincorporated businesses are taxed will change from 6 April 2024.
Talk to us about your tax planning
If you’re an unincorporated business and need to get your tax planning under control, please contact your RfM Advisor. 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.