The profit and loss account structure of your business accounts, while more than adequate for the purpose of running the business, is not sufficient for working out the likely tax due. One of the main areas that needs to be taken into account is expenses, it is imperative to keep all receipts, not only for accounting purposes, but also in case the Inland Revenue query your tax return.
You will need to ensure that any expense that may have seemed reasonable in the management accounts meets the more stringent requirements of the tax authorities. You are generally allowed to set an expense against your income if it is:
- Incurred wholly and exclusively for the purposes of trade
- Properly charged against income (not, for example, purchase of a property lease, which is capital)
- Not specifically disallowed by statute
Expenses to be adjusted
The adjustments to be made to the profit, as shown in your profit and loss account, to arrive at your taxable profits include the following:
- Any depreciation on fixed assets needs to be added back to profits, as these are not an allowable business expense
- Deduct a writing down allowance for any new capital expenditure made in the period; the rate is changed in the annual budget and varies from 25% to 100% depending on the particular item purchased
- Deduct the writing down allowance for capital expenditure made in earlier years, this may be at a lower rate or be a diminishing sum (motor vehicles are written down at 25% on the declining balance)
- Add back personal telephone charges if business and personal telephone use overlap, mobile phone calls also come under this heading
- Any use of stock for personal use, for example food products if you run a grocery outlet, also need to be added back to profits
- Add back entertainment expenses to profits
- Add back drawings made during the year
- Heating, lighting and other property charges if the business is run from home need a proportion added back to profits
Note that charging back proportionate costs (heating/gas/electricity etc) if the business is run from home may result in your Local Authority re-calculating your Council Tax liability, to take account of that part of the dwelling that would then be considered as commercial premises. In order to escape re-valuation by your Council you must be able to demonstrate that the part of the building used for the business does (or can) revert to domestic use for some part of the day.
Working out the tax bill
After you have made these adjustments you will have arrived at the taxable profits. The tax due will be the prevailing rate applicable to your business.
- Sole traders and partners will be taxed at their marginal tax rate which varies between 10 and 40%
- Companies are taxed according to the amount of profit they make. If you make less than £10,000 per year the tax rate is zero, if you make between £10,000 and £300,000 the tax rate is 19%. Thereafter it increases to a maximum of 30%
- Directors of limited companies pay tax on PAYE