Joseph G. Bourke FCCA

 

Starting a business

One of the first issues for a new business to decide is the format in which to operate. The first consideration should be the nature of the business. If there is a serious risk of litigation or substantial creditors are likely to be a regular feature of the business the potential problems of personal liability would suggest a limited company format.

Businesses that fail often owe substantial amounts to Customs & Excise and the Inland Revenue. The possibility that these debts might lead to personal bankruptcy for a sole trader or partner should be considered at the outset.

Primary tax considerations

Normally where all profits are being drawn out it is better from a tax viewpoint to operate as a sole trader or partnership. This is mainly due to the operation of National Insurance contributions although the effects of this can be overstated.

Example 1

A sole trader makes a profit of £26000. Ignoring personal allowances for simplicity, his liability to tax and NI for 2000/01 is calculated as follows:

£

Tax 1500 @ 10% 150

24500 @ 22% 5390

NI Class 2 104

Class 4 1513

------

Total deductions 7007

Gross Income 26000

-------

Net Income 18993

 

 

 

 

 

Example 2

In this example the sole trader operates through a limited company and pays himself a salary of £23648 in order to leave £2352 to pay employer’s NI.

 

£

Tax 1500 @ 10% 150

22148 @ 22% 4873

NI Class 1 employee 1969

-------

Total deductions 6992

Gross salary 23648

-------

Net Income £16656

 

As these examples show the effect can be significant. It is for this reason that the owners of many small companies take small salaries and receive a significant part of their income as dividends that are nor subject to National Insurance.

Example 3

As in the above example, the sole trader operates through a company that has made £26,000. This time he distributes the whole amount in dividends.

Corporation tax on £10,000 @ 10% £1,000

Corporation tax on £16,000 @ 22.5% £3,600

---------

£4,600

In this case net income is £21400.

A further refinement is to pay a salary that covers any personal allowances and the lower rate of tax at 10 per cent, accepting the small NI liability that will result in exchange for the state benefits it preserves and then paying the remainder in dividends.

 

Other taxes

Capital gains tax on the future sale of a business is worthy of consideration at the outset. There are a number of important relief’s available to owners of business assets that may be more difficult to benefit from in the case of a limited company.

While shareholdings can qualify for business asset relief’s including taper relief and rollover relief there are more hurdles to jump for companies than sole trader’s or partnerships.

Likewise with inheritance tax the unincorporated business may have advantages in terms of claiming relief’s.

 

 

 

Business Capital

Sole Trader

There are three main ways that a sole trader is likely to raise finance for a business start-up:

· Overdraft or bank loan

The interest in normally tax deductible but may be challenged by the Inland Revenue where drawings from the business exceed the profits i.e. where the loans funds are not used wholly and exclusively for business purposes.

· Increasing mortgage on a main residence

Where an additional separate loan is taken the interest on the new loan can be claimed. If the existing mortgage is repaid and a new increased loan is taken out the interest will need to be apportioned between the business expense (deductible) and home mortgage interest (not deductible).

· Borrowing from friends and relatives

If interest is paid on these loans it is taxable in the hands of friends and relatives

 

Partnership

Although there is no such legal person as a partnership in England and Wales a partnership may still take out a loan in the partnership’s name and interest will be allowed as a tax deduction.

If individual partners borrow money in their own name and invest it in the partnership, relief will be given to the individual partner against his or her share of the partnership’s taxable profits.

 

Share Capital

Finance can be raised for a company by issuing share capital or by introducing the funds as loans.

Share capital cannot subsequently be withdrawn without a tax charge while loans can be repaid without tax consequences. For this reason many start up companies begin with a small amount of share capital until the business is well established.

Interest is generally paid from a company under deduction of tax. This is most often forgotten when the loan has been raised from family and friends.

 

 

Plant and Equipment

The start of a business is the point at which existing plant and equipment is often brought in. A valuation of any assets introduced should be undertaken as they may qualify for capital allowances.

Proprietor’s Car

Sole traders and partnerships’s – statutory approach

The strictly correct approach for sole traders and partners is to bring the car into the business like any other asset which is already owned personally. The running costs of the car would also be brought in as a business expense. A proportion of these charges will be added back for private use in calculating taxable profits.

If the business is VAT registered, Customs & Excise will allow the VAT on repairs and maintenance to be reclaimed in full. The proportion of VAT on fuel attributable to private use cannot be reclaimed.

Sole traders and partnership’s – FPCS approach

An alternative approach for traders who have a turnover less than the VAT registration limit is to use the Inland Revenue mileage allowances based on those for the Fixed Profit Car Scheme.

Companies

The first option is to bring the car into the company. While the company can deduct the car expenses the director will be liable to income tax on the scale benefits as determined each year by the Inland Revenue.

The alternative is to keep the car as a private asset and charge the company FPCS mileage allowances for business travel. This approach has become more favourable in recent years as company car scale charges have risen dramatically.

 

Equipment qualifying for capital allowances

Short life election

Assets that are likely to be sold or scrapped within a period of five years should be separately identified so that a balancing allowance may be claimed at the appropriate time. Computers and other IT equipment currently qualify for a 100% first year allowance.

Renewals Allowance

If a business starts with second-hand equipment that is not expensive and intends to replace it within a few years with new equipment the use of the renewals basis would provide for no deduction in respect of the original equipment but full deduction for the replacement assets in the year of purchase.

 

Trading Matters

Pre-trading expenditure

Sole traders and partnerships

It is possible to claim pre-trading expenditure incurred at any time in the previous seven years if the expenditure has been incurred by the person starting the trade and is of a type that would have been allowable had it been incurred at the start of a trade.

Companies

Companies cannot incur pre-trading expenditures until they are incorporated although they may purchase assets including intellectual property from the individuals forming the company.

 

Accounting Date

For unincorporated businesses a 31 March year end is convenient for tax purposes and avoids overlap of taxable profits in the first years. In the absence of commercial reasons it is recommended that this date be adopted in all cases.

Companies will normally adopt a year end 12 months after incorporation unless an alternative date is commercially prudent.

 

VAT Registration

A business must register for VAT when its turnover of taxable supplies in the previous 12 months has exceeded the VAT registration limit. Most start up businesses, therefore, do not have to register immediately.

Voluntary registration may be beneficial in some cases if sales are predominantly to business customers. It is generally not beneficial for retail trades or other businesses’s that sell at an inclusive price to non-vat customers.

 

PAYE

If any employees are to be taken on then the business must register as an employer. This applies even in the case of casual employees.

 

Accounting Records

Both the Inland Revenue and Customs and Excise require businesses to keep adequate accounting records. There is no statutory definition of what comprises adequate accounting records. The general rule is that your records must be kept in such a way that Customs and Excise officers or Inland Revenue officials can check and verify the figures that you have used to fill in your tax returns.

In the case of companies there is a statutory provision to maintain adequate accounting records.

You must normally keep your business records for six years. Examples of business records from the VAT guide include:

- orders and delivery notes

- relevant business correspondence

- appointment and job books

- purchase and sales books

- cash books and other account books

- purchase invoices and copy sales invoices

- records of daily takings such as till rolls

- annual accounts, including trading and profit and loss accounts

- import and export documents

- bank statements and paying-in slips

- your VAT account

- any credit or debit notes you issue or receive

 

When starting a business you should open a business bank account separate from your personal account. All business receipts and payments should go through your business account.

Keep an account book to identify all receipts and payments whether cash or cheque and maintain a file of paid invoices/receipts. Cash businesses should record daily receipts before deduction of any cash/till payments to reconcile takings with deposits to the bank.

 

If you are VAT registered the account book should make provision for recording VAT on your daily receipts and payments.

If you employ staff you will also need to maintain a wages book to record wages paid and tax and national insurance deducted.

Keeping well organized records will assist in reducing accounting fees and in managing inspection visits from Customs and Excise and the Inland Revenue.

 

 

Financial Advice

 

It is a sad fact of life that the overwhelming majority of new businesses fail in their early years and poor cash management is often a significant contributory factor. If you experience cash flow problems and are finding it difficult to meet your liabilities seek advice at an early stage. If the business fundamentals are sound you may be able to raise finance to allow the business to develop its revenues and stablise it’s cash position.