John Davison outlines the tax reliefs and allowances available to small businesses that earn income as a sole proprietor or in a partnership. Income earned through a company is subject to corporation tax.

Issue

To minimise tax payable, it is necessary to understand the allowances and reliefs available. This covers the main reliefs and does not cover reliefs such as Married Person’s Allowance and Maintenance Payments that are applicable to persons born before 6 April 1935 and other infrequently used allowances. These are the allowances and reliefs for 2019/20. It should be noted that there are slight differences in Scotland.

Allowances

These allowances are available for individuals not companies.

Allowance

2019/20

Personal Allowance*

£12,500

Basic rate threshold (20%)

£37,500

Higher rate threshold (40%)

Taxable income over £37,500

Additional rate threshold (45%)

Taxable income over £150,000

Capital gains Tax threshold

£12,000

*Where income is over £100,000, £1 of personal allowance is lost for each £2 earned

Example, Joe earns £70,000, his tax is:

Joe’s Taxable Income is £70,000 - £12,500 = £57,500

Basic rate tax at 20% on £37,500 = £7,500

Higher rate tax at 40% on £20,000 (that is £57,500 - £37,500) = £8,000

Total tax is £7,500 + £8,000 = £15,500

National Insurance is also payable and this is discussed below.

Savings Income Allowance

A certain amount of interest is not taxed. The allowance differs for each band of tax.

  • Basic rate taxpayers can earn up to £1,000 in savings interest;

  • Higher rate taxpayers can earn up to £500 in savings interest;

  • Additional rate tax payers do not have a savings interest allowance.

Tax free savings such as ISAs are not included in this allowance. The allowance can be used against income earned on bank interest, government or corporate bonds, peer-to-peer lending interest and interest distributions from investment trusts, authorised open-ended investment companies and bond funds. It does not apply to dividends (see Dividend Allowance).

There is also a savings starter rate that applies in addition to the personal savings allowance. This is useful to those that pay low amounts of tax, such a new business (if the business is run as a sole proprietor or partnership). The allowance is £5,000, but earnings in excess of the personal allowance reduce this allowance. This allowance is in addition to the personal allowance and the savings allowance. A person will pay no tax if they earn no more than £18,500 (the personal allowance of £12,500, plus the starter rate of £5,000 and the personal savings allowance of £1,000). When tax is calculated the income from earned income is considered first, then the savings income. So, for example, person earning £15,000 from their work, plus £6,000 in interest income will pay tax as follows:

Personal Allowance £12,500

nil tax

20% on remaining earned income (£2,500 @ 20%)

£500

0% tax on savings of £2,500 (that is the £5,000 starter less the £2,500 used up from earnings in excess of the personal allowance)

nil tax

0% on the next £1,000 of savings (personal savings allowance)

nil tax

Remaining savings £5,000 – (£2,500 + £1,000) @20%

£300

Total tax

£800

Dividend Allowance

The first £2,000 received in dividends is tax free. This is a reduction in the tax-free allowance allowed in 2018/18. Dividends in excess of this will be subject to tax of 7.5% for a basic rate tax payer. Higher rate pay 32.5% tax and Additional rate taxpayers pay a tax rate of 38.1%.

Tax is not due on shares held in ISAs. Holdings in mutual funds such as unit trusts and open-ended investment companies are subject to the dividend tax if they are investing in equities. Shares that are sold will be subject to Capital Gains Tax.

Deductions from profits

To calculate the taxable income of the business, the expenditure of the business is deducted from the revenue of the business. Some items are not deductible, such as business entertainment expenditure. Also, capital items do not benefit from the full cost deduction as the cost is spread over a period of years, for the expected life of the asset (this is called a capital allowance). The calculation of these deductions is beyond the scope of this newsletter.

Mileage Allowances

HMRC publish mileage allowances that can be claimed as an expense when calculating taxable profits. The rates per mile are currently:

First 10,000 miles

Over 10,000 miles

Car/van

45 pence

25 pence

Motorcycle

24 pence

24 pence

Bicycle

20 pence

20 pence

It should be noted that there are also advantageous allowances for company bike schemes.

Tax reliefs for those working from home

Where a business has a base away from the home (for example a shop or office) then HMRC will not allow any claims for expenditure at home. An itinerant worker or a person working full time from home can reclaim some costs. It should be noted, however, that capital allowances cannot be claimed for building costs or conversion costs other than some wiring costs, furniture and moveable partitions.

The business working from home can claim a proportion of costs for items such as power bills, Council Tax, mortgage costs or rent and telephone and internet use. It is necessary to find a way to divide the costs between home use and work use, usually on the basis of number of rooms and time.

For example, if there are five rooms in the property and one room is used for work for 8 hours a day, HMRC will accept a claim of the costs X 1/5th X 8/24th.

Where there is only a minor cost (such as £2 a week, HMRC will accept the claim without any backing documentation).

HMRC give some further examples at, https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim47825.

There is also a simplified basis for expenses. For example, there is a flat rate deduction if business use is at least 25 hours a month. The flat rate deduction that can be claimed as an expense is:

Business use hours per month

Flat rate per month

25 to 50

£10

51 to 100

£18

Over 100

£26

Where a property is used to carry on a business a simplified expense calculation can be undertaken instead of calculating the split between private and business use. This is based upon deducting an amount from total home expenses depending on the number of people at home.

Number of people

Flat rate per month to be deducted

1

£350

2

£500

3 or more

£650

For example, if there are four people at home and total business costs for the home (electricity council tax etc.) is £12,000 per annum (or £1,000 a month), the total amount that can be deducted is:

£1,000 less £650 = £350 a month tax claim.

National Insurance

There are different rates of National Insurance Contributions (NIC) for employees, employers as well as the self-employed. The business needs to calculate the NIC to be deducted from employee wages for both the employee and employer contribution. NIC is usually calculated weekly. The rates are as follows:

Employee NICs

2019/20

2019/20

Weekly

Annual

Lower Earnings Limit – earnings below this amount do not attract NICs

£118

£6,136

Primary threshold - earnings below this amount do not attract NICs

£166

£8,632

Upper Earnings Limit – Earnings between the Primary and Upper earnings limit are taxed at 12%

£962

£50,000

Earnings above the Upper Earnings Limit are taxed at 2%.

Note, where the employee earns between the Lower Earnings Limit and the Primary threshold the employee is entitled to NI credits.

Employer NICS above the Secondary Threshold (£166 weekly, £8,632 annually) are taxed at 13.8%

Self-employed NICs

2019/20

Annual

Small Profits Threshold – earnings below this threshold do not attract NICs

£6,365

Class 2 NICs – for earnings above the Small Profits Threshold

£3 per week

Lower Profits Limit – Earnings up to this limit only incur Class 2 NICs. Over this limit Class 4 NICS are payable at 9%

£8,632

Upper Profits Limit – Earnings up to this limit incur:

Class 2 NICs

Class 4 NICs at 9% of the profit between the Lower Profits Limit and Upper Profits Limit

£50,000

Earnings above the Upper Profits Limit

Earnings above this limit incur

Class 2 NICs

Class 4 NICs at 9% of the profit between the Lower Profits Limit and Upper Profits Limit, and

Class 4 NICs at 2% of the profit above the Upper Profits Limit

Capital Gains Tax

Tax is also due on any gains made on capital items, but this is beyond the scope of this newsletter as it mainly impacts investment activity rather than trading businesses and specialist advice should be sought due to its complexities. But, it should be noted that there is a special Entrepreneurs’ Relief. The main Capital Gains Tax (CGT) exemptions and rates are:

Annual exemption from capital gains: £12,000

Rate 2019/20

Basic Rate Taxpayer

Residential property

18%

Other chargeable assets

10%

Higher Rate Taxpayer

Residential property

28%

Other chargeable assets

20%

Entrepreneurs’ Relief

10%

Entrepreneurs relief is available for:

  • Assets used in an individual’s business or partnership (but excluding some assets such as goodwill and shares and securities) that are part of the disposal of all or part of the business;

  • Assets used in an individual’s business or partnership that have been disposed of within three years after the time the business ceased; and

  • Shares or securities in an individual’s personal company that are disposed of whilst it is a trading company (or where holding company shares are disposed of, the group is a trading group) or within three years from the date the company ceased to be a trading company of a trading group.

This includes assets held personally by the individual used in the businesses. Businesses includes most business other than property letting, although furnished holiday lettings in the UK or European Economic Area are included.

There is a lifetime limit of £10 million for Entrepreneurs’ Relief.

Should this relief be claimed, there are many other complications so advice should be sought.

Conclusion

There are many tax reliefs available for businesses. It is worth investigating the amounts that can be claimed as this will reduce the tax bill of the business.

Last reviewed 22 November 2019