How to minimise the tax you pay on your business profits

Businesses pay taxes on the profits they make. All businesses must make a return to HM Revenue & Customs (HMRC) advising them of their trading results in the last year.

These returns will be based on the financial accounts of the business. If the business is a sole trader or partnership they are legally required to complete a self-assessment self-employment tax return.

For accounts for the year ended on or before 5 April the return must be filed on-line by the following 31 January. Limited companies have 12 months to file a corporation tax return and accounts with HMRC and nine months to file accounts with Companies House.

Clive Lewis, head of enterprise at ICAEW, shares tips for entrepreneurs on minimising tax payments.

Good record-keeping ensuring all expenses included

As business taxes are based on information from financial accounts it follows that the accounts should be as accurate as possible.

HMRC has the right to challenge figures in returns submitted to them as well as contacting businesses to check that their record-keeping is a reliable basis for calculating the business' tax liability. HMRC can levy penalties for incorrect returns. Small businesses should keep a separate bank account where only business transactions are recorded.

Use of a credit card can also be a way of keeping track of business expenses.

Claiming all expenses

Small businesses often regard record-keeping as a chore, but ensuring all expenses are included in the accounts can help minimise tax and national insurance costs. Areas where small businesses often miss or overlook are use of a home as a business base, motoring expenses and cash payments.

Use of home as business base

HMRC will accept a claim of up to £4 a week without evidence. If the claim is any greater they will expect claims for use of house as business premises to be supported by detailed expenditure calculations (excluding any mortgage interest).

The charge to the business must be based on the area of the house used for business as a proportion of the total area.

Motoring expenses

Many unincorporated businesses charge their accounts with the full cost of running a motor vehicle. HMRC will require that records are kept of the business mileage and a reduction in the motoring cost for the proportion of personal use.

Unless the vehicle is a van which is used wholly in the business it is rarely tax-efficient to put motor vehicles into a limited company's accounts because of the "benefit-in-kind" which the driver will be assessed to tax on.

In these cases the use of a private vehicle is calculated by recording the business mileage and charging the business at the HMRC agreed rate of 45p per mile. (for the first 10,000 miles p.a.) and 25p per mile above 10,000 miles. These calculations must be made based on use per tax year.

Cash payments

If you make cash payments for the business, you must keep the receipts in a file and regularly record the payments otherwise it is easy to overlook the costs.

Start-up businesses: Expenditure before starting

Preparing to start a business can take some time and involve an initial outlay sometimes running into thousands of pounds. It is important to keep a record of all expenses incurred before the start of trading as these expenses can be claimed in the first year's accounts.

Business format

Recent changes to the taxation of companies, including the taxation of dividends, have made forming a limited company less tax-efficient.

Because a limited company carries additional regulatory requirements, it is unlikely that individuals will pay less in tax and National Insurance
contributions unless the business is making profits of £35,000 to £40,000 a year. Although there are other reasons why it would be advantageous to form a limited company.

Claiming all allowances

Expenditure on a capital asset (one which will benefit the business for more than a year) such as office equipment and plant and machinery is usually written off as a cost in the accounts of a business over the useful life. The annual charge is known as depreciation.

HMRC does not allow depreciation as an expense in calculating taxable profits but has its own expense rules for use of capital assets called capital allowances.

The main allowance is the annual investment allowance (AIA), which allows as a deduction from taxable profits of the capital cost of plant and machinery (not cars) of up to £200,000.

Where purchases exceed the AIA, a writing down allowance (WDA) of 18% is available.  Special rates apply for claiming capital allowances on motor vehicles, based on their cost and CO2 emissions.

Assets bought on hire purchase are treated as fully acquired from the start and eligible for capital allowances. The accounting treatment of finance leases follows hire purchase and capital allowances claimed. With operating leases the cost of the lease payments can be charged against business profits.

Cash basis for preparing accounts

Since April 2013 unincorporated businesses have been allowed to state profits for tax purposes on a 'cash basis' rather than an 'accruals basis'.

This means reporting transactions when money is paid or received rather when invoiced. This can benefit growing businesses with increasing working capital needs. The 2017 Spring Budget increased the size of business allowed to use the cash basis from a turnover (or sales) of £83,000 to £150,000.

Pension contributions

Self-employed people are entitled to relief at their top rate of tax on contributions to personal pension schemes, provided it is a registered scheme, subject to relevant earnings and annual and lifetime allowance limits.

Tax on the sale of a business

Capital gains tax is chargeable on the gains accruing on the disposal of an asset. This includes the sale of a business or the sale of a business' goodwill. There is an annual exemption for individuals which means the first £11,300 of chargeable gains are tax free.

Capital gains tax rates are 10% for a basic rate taxpayer and 20% for a higher rate taxpayer. However, entrepreneurs relief which can apply to the sale of a business is 10% with a lifetime allowance of £10 million.

Seek tax help from ICAEW Business Advice Service

If you believe you're paying too much tax on your business profits or are concerned that your record-keeping may not stand up to challenge from HMRC, a discussion with an ICAEW business adviser can help.

Get free advice here