TAX – WHO PAYS WHAT?
One question I get asked a lot is who pays what tax .. so here’s your handy cut out and keep guide!
A limited company is a separate legal entity and so pays tax in it’s own right. It pays corporation tax on it’s profits. If it’s sales are high enough then it will also be VAT registered and broadly speaking will charge VAT on it’s products and services (some products and services are exempt) and this is generally at 20% (although there are some at 5% and some that are at 0%), it then pays this VAT less VAT it can reclaim on it’s own purchases to HMRC on a quarterly basis.
If the limited company has employees (this may be just one director or there may be more) then it will pay Employers National Insurance (NI) on the salaries and wages it pays to it’s directors and employees (subject to allowances) and will also pay employer pension contributions at a minimum under auto-enrolment legislation or it may have it’s own company pension schemes in place that it pays into.
The directors of a limited company will pay their own income tax and employees NI on the salaries that they receive.
The shareholders (owners) of the company (who aren’t necessarily the directors .. think big plc’s .. you can own shares in Tesco but aren’t a director!), will pay tax on the dividends that they receive, again subject to the allowances in place.
Sole trader / partnership
If a business is run as a sole trader or as a partnership then the tax is the same – the sole trader or each partner are treated as being the same as the business / the business is the same as the person and they are taxed personally on the profits of the business which means that they pay income tax and national insurance on the profits that they make. Any salary that they draw out of the business is ignored for these purposes and it is the profits before the money they take out that is taxed.
A sole trader / partnership may also be VAT registered and will charge, reclaim and pay VAT as a limited company above.
A sole trader / partnership may also have employees and will then pay employers NI on their employees salaries.
All employees will pay income tax and employees NI (above the thresholds) and this is deducted by their employer each month and paid to HMRC via the Pay As You Earn system (PAYE) by the employer. This means that the majority of employees don’t have to complete self assessment tax returns and don’t have any additional tax to pay from their employment.
If an employee also receives dividends from investments, or bank interest over £1k (£500 for higher rate tax payers), or has an investment property then they need to declare this income and pay tax via self assessment.
This is just the basics and that old HMRC advert of tax doesn’t have to be taxing is clearly wrong as it’s not simple and straight forward!