Setting up Your Business – Part 2

Last week’s Setting Up Your Business – Part 1, reviewed two potential options for your new set ups business structure. After assessing if Sole Trader and/or Partnership is right for you, if you feel that you are ready for something larger, a Limited Company might be right for you, this weeks installment will run through the basics to help you make the right choice for you.

A Limited Company is an entity in its own right and is responsible for everything that it does. Its finances are kept separate to your own personal finances.

A Limited Company is operated by Directors who are responsible for running the Company in the best interests of the shareholders. The Directors may also be shareholders.

As a director of a limited company, you must:

  • try to make the company a success, using your skills, experience and judgment
  • follow the company’s rules, shown in its articles of association
  • make decisions for the benefit of the company, not yourself
  • tell other shareholders if you might personally benefit from a transaction the company makes
  • keep company records and report changes to Companies House and H.M. Revenue and Customs (HMRC)
  • make sure the company’s accounts are a ‘true and fair view’ of the business’ finances
  • file your accounts with Companies House and your Company Tax Return with HMRC
  • pay Corporation Tax
  • register for Self-Assessmentand send a personal Self-Assessment tax return every year – unless it’s a non-profit organisation (eg a charity) and you didn’t get any pay or benefits, like a company car

You can hire other people to manage some of these things day-to-day such as a Certified or Chartered Accountant, but you’re still legally responsible for your company’s records, accounts and performance. You may be personally liable for your company’s business liabilities and be fined, prosecuted or disqualified as a company director if you do not follow the rules.

There are three ways in which you can draw money from a Limited Company:

Salary, expenses and benefits

The Limited Company can register as an employer and you can then draw a Salary from the Company. You will pay Income tax and National Insurance in the same way as any other employee however, as a Director you can defer your National Insurance Contribution deductions until your actual salary reaches the annual threshold. The Company will also pay employers contributions to HMRC with respect to your salary.

Reasonable expenses incurred wholly and exclusively in the course of the running of the business can also be claimed from the Company.

If you or an employee of the Company uses items owned by the Company personally then this must be reported as a benefit received and may also be subject to income tax. There are also some benefits that are ‘tax free’ for the employee however each one is subject to specific rules:

  • Workplace car parking
  • Pension contributions
  • One mobile phone
  • Staff parties (costing up to £150 per head)
  • Qualifying child care (basic rate tax relief only)
  • Relocation costs
  • Relevant training
  • Bicycles
  • Long-service awards
  • In-house gyms and sports facilities
  • Cheap/free canteen meals
  • Gifts unconnected with work (e.g. wedding gifts)
  • Electric cars
  • Business mileage payments
  • Work and safety clothes
  • Overnight expenses if away on business

In addition to the tax free benefits, further savings can be made. With many benefits-in-kind, the employee has to pay Income Tax at the usual rates and the employer has to pay National Insurance at but there is no employee’s National Insurance. Most benefits-in-kind will therefore provide a saving with respect to employee’s National Insurance. For a basic rate tax payer this is an attractive prospect. These types of benefits would include things such as paying for an employee’s gym membership.

Dividends

If your Company makes a profit, then the shareholders can be paid Dividends. The first £5,000 of dividend income in each tax year will be tax-free. Sums above that will be taxed at 7.5 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate taxpayers. The new tax came into effect on April 6, 2016. No tax will be deducted at source and taxpayers must use self-assessment to pay any tax due.

Directors Loans

If you draw more money from the Company that you have put into it then this would be classified as a Directors Loan. If your company makes directors’ loans, you must keep records of them. You may have to pay tax on director’s loans. Your company may also have to pay tax if you’re a shareholder (sometimes called a ‘participator’) as well as a director. Your personal and company tax responsibilities depend on how the loan is settled. You also need to check if you have extra tax responsibilities if:

  • the loan was more than £10,000 (£5,000 in 2013-14)
  • you paid your company interest on the loan below the official rate

After reading this two part summary of the potential business structures available to you, you will note that there are pros and cons each structure and what may be right for one start up may not be fit for another. Discussing your options with an Accountant will help you to make the best decision for you. You can view our Choosing Your Accountant article from the beginning of the month if you don’t already have one selected. Don’t forget, if you are a contractor, then you might need to deal with a specialist firm of Accountants for Contractors as there are also other considerations (we provided more details about this in Part 1 if you’ve only just joined us).

Setting up Your Business – Part 1

Once you have your Business plan in place you will need to ensure that you follow the correct steps to get things run smoothly and that you remain tax compliant. If you are currently working full time and intend to begin your new venture on a part time basis until you are ready to expand further, then you will need to take this into consideration when deciding on the best business structure.

The best business structure is whatever works best for you and depends upon your personal circumstances. The business structure you choose will define your legal responsibilities such as how your profits are taxed, how you can personally draw profit from the business and your personal responsibilities if the business makes a loss.

This week we will delve into a couple of the business structures that might work for your start up;

Sole Trader

Running your own business as an individual you are responsible for everything from the day to day work right through to paying the taxes. You can employ staff to help with the work if required and you would be solely responsible for ensuring that the relevant taxes are accurately calculated, reported and paid. If the business cannot meet its financial obligations then it would be your responsibility to cover the bills personally, likewise, if the business makes a profit you are free to spend the money as you choose.

The taxes when trading as a sole trader are reported annually through Self-Assessment. You should budget to cover your tax liability to ensure that payments due are made on time in order to avoid penalties for late payment.

The current financial year runs from 6th April 2016 to 5th April 2017 and the standard personal tax free allowance is £11,000. Depending on your personal circumstances you may have a different personal allowance for example, if you are entitled to Marriage Allowance or Blind Persons Allowance then it would be higher and if your total taxable income exceeds £100,000 then it would be lower. You would have no personal allowance if your taxable income exceeds £122,000

The current income tax rates are set out in the table below:

Band Taxable income Tax rate
Personal Allowance Up to £11,000 0%
Basic rate £11,001 to £43,000 20%
Higher rate £43,001 to £150,000 40%
Additional rate over £150,000 45%

In addition to Income tax, you should also expect to pay National Insurance. When Self Employed there are two types of National Insurance that you should take into consideration:

Class 2 National Insurance is due when profits are £5,965 or more per year, the current rate is £2.80 per week

Class 4 National Insurance comes into effect when your profits are £8,060 or more per year. It is calculated at two levels:

  • 9% on profits between £8,060 and £43,000
  • 2% on profits over £43,000

Income tax is generally calculated at the end of the financial year through completion of a Self-Assessment Tax Return. The Return will need to be submitted to H.M. Revenue and Customs no later than 31st January following the end of the financial year giving you almost 10 months to ensure that your accounts have been accurately formulated and that the calculations are correct. The balance of any Income Tax and National Insurance due will also need to be paid on or before this date and if the tax liability exceeds £1,000 you will also be required to make your first payment on account towards the following tax year at this time. This is normally 50% of the tax liability for the current year. A further payment on account would then become due on 31st July.

If you are working as a Sub-contractor within the Construction Industry, then how you pay income tax will be managed differently. In this instance you would be required to register with HMRC under the Construction Industry Scheme. When you work for a contractor they would then deduct 20% of your income as CIS Tax, this will be paid directly to H.M. Revenue and Customs and is then offset against your Tax Liability when completing your Self-Assessment Tax Return. If you have paid too much tax H.M. Revenue and Customs will issue a refund of the surplus balance, if you have not paid enough then you will have to make up the shortfall.

To set up as a Sole Trader your will need to register as Self Employed with H.M. Revenue and Customs. You can give your business a name but you must also ensure that your own name is also present as proprietor on all of your business correspondence.

If you decide to take on an employee you must also register as an employer and if your turnover exceeds £83,000 you should also register for VAT and process quarterly VAT Returns, ensuring any VAT is paid when due. There are plenty of fixed price Accountants who can privide all the information you need on these aspects of running a business, so look for an Accountant East London startups and small businesses have been trusting with their fledgling finances.

Partnership

If you are setting up a business with one or more people you would not be able to set up as a Sole Trader, in this scenario you may consider an ordinary business partnership.

In a partnership you and your business partners share the responsibilities of the business personally and the business partnerships can be shared between the partners and each would pay Income Tax and National Insurance on their share of the profits in the same way as a sole trader would. The share of the profits does not have to be in equal percentages and just like a sole trader you would be liable for any losses incurred.

You should register a business name with HMRC when you register your partnership and allocate a nominated partner to act as the spokesperson and signatory for the business with respect to its statutory filing requirements.

Your business partner does not have to be another individual, a Limited Company, being an entity in its own right and therefore classed for taxation purposes as a ‘Legal Person’, could also become a partner.

If you do not want to be personally liable for any potential business losses, then you may also consider the option of setting up a Limited Liability Partnership (LLP) instead. Partners in an LLP are not personally liable for the debts of the business, their liability is limited to the to the amount of money they invest in the business (we’ll look into this further in next weeks continuation of Setting up Your Business).

This article gave a brief overview of the CIS Scheme with respect to Sole Traders however it is a far more detailed subject that, if relevant, should be covered in more depth. The CIS Scheme is also relevant to partnerships and Limited Companies too however the process of offsetting and reclaiming overpaid tax is different and more complex. Contractors working outside of the Construction Industry through a Limited Company should also speak with their Accountants regarding IR35 (Intermediaries Legislation) which is the tax and National Insurance contributions legislation that may apply if you’re working for a client through an intermediary such as a Limited Company. If IR35 applies, all payments to the intermediary are treated as your employment income and the intermediary must pay any tax and National Insurance contributions due. It ensures that you pay roughly the same amount of tax and National Insurance contributions as if you’d been directly employed by the client. Like CIS, this is a complex aspect which would require further exploration if applicable. It’s best to seek specialised tax advice for Contractors as the rules and regulations will be different to set ups for other business types – specialist contractor Accountants will be able to advise you of exactly what is and what isn’t applicable to your situation.

Join us next week for part two of our guide to business structures to learn more about setting up as a Limited Company and how this might be the right selection for your business.

The Bumps in the Road

For many start ups, the beginning can be a bit like living hand to mouth, and the financial bumps in the road caused by bad clients, poor cash flow etc, can be quite a challenge. If the challenges did become too much, you might find yourself considering Insolvency and in need of advice from an Insolvency Practitioner but I wanted this article to look at how to manage common financial issues (the big and the small) in the first months/years of a new start up business to avoid letting the bumps get the best of you.

Starting a business is a major life step change. There are many early financial challenges that need management and planning. Approach and execute these in a systematic way.

Planning

Planning a new business venture is fundamental to its success. Financial planning involves budgeting and putting required finances in place.

Budgeting involves estimating revenues and expenses for the business monthly, usually for its first three years. You need to be confident that the business will generate a profit after all costs, and enough profit to give you an income that you can live on.

You next need to extend that into a cash flow forecast which anticipates the bank receipts and payments monthly. This will indicate the finance requirements of the business, which will include monies you can invest in it at the start, and external finance such as a bank overdraft facility. If adequate finances are not available to fund the cash flow forecast, then the project is not viable. This could lead you to look at other potential sources of finance (such as crowd funding) revisiting the budget to cut its scale; or abandoning the project completely.

The final step is to test the model for risk. What is the effect on profitability and/or cash flow if: sales are 10% less than expected; stock purchase prices rise unexpectedly; or bank interest rates increase? You then need to consider strategies for these events, and look at ways of mitigating the risk. For example if the risk of a customer going bust before they pay you would devastate the business cash position to the stage where it would itself run out of money, then appropriate mitigation might be improved credit vetting procedures and taking out bad debts insurance.

Most new businesses fail because they run out of cash. As a general rule longer life assets (plant and vehicles) should be financed by long term finance (hire purchase or bank loan.) Other working capital cash requirements should be funded by cash introduced personally and/or bank overdraft. Be wary of introducing funding yourself that you have had to borrow personally (e.g. credit cards or home equity loans.) If the business fails then you are going to have to live with the consequences for years after.

Check with your accountant or tax helpline whether or not you need to register for VAT or PAYE. If you are liable to do so and do not do so then there are financial penalties and back-dated recoveries. With many businesses such as eBay traders, VAT registration can dramatically affect the profitability, and it may well be worth restricting the business sales to below the registration thresholds.

Recording

It is necessary to record the businesses actually performance to comply with tax legislation and also to see how actual results compare against your budgets so that you have early warning of potential problems and can act on them. There are a lot of time demands on the entrepreneur, and it is easy to under-resource bookkeeping and reporting at the price of say marketing activity. Follow certain rules to make the process simpler and more accurate.

Choose a simple bookkeeping system that is not over-sophisticated for the nature of what you are doing. Solicit external bookkeeping help if accounting matters are complicated or there are a large number of transactions.

All business expenses need to be recorded, otherwise a false picture of profitability is given. Many costs are incurred between having the business idea and achieving the first sale (e.g.: professional fees; marketing; company formation; visits to suppliers.) These are all business expenses and should be recorded as such. Similarly when the business starts you might use a personal asset (e.g. a laptop) for business use; use your own car; or dedicate part of your house for a business office. These costs should be apportioned and recorded.

Open a separate business bank account. All business transactions should go through it. Draw your salary to live on as one monthly amount. Don’t take out varying small amounts of money as personally needed. Don’t put any other personal expenses through the business account, and don’t pay business expenses through your personal bank account or credit card.

Prepare monthly accounts and don’t rely on the bank balance as a measure of success. Some of these bank funds may be PAYE or VAT and don’t belong to the business.

Consider using relevant tax elections available to reduce the administrative burden on small business (e.g. Annual PAYE; and the Flat-rate, Annual Accounting, and Cash Accounting VAT schemes.)

Monitoring

So we have a plan, and when we start trading a monthly record of how well we have done against that plan.

Act on any large negative variances, for example if sales fall below budget the need for greater advertising spend may be indicated. If things do not move to correct themselves in future months more dramatic action may be required: get a part-time job to supplement business income; or cut the size of the workforce.

On the other hand if things are going better than planned, don’t immediately take out a cash bonus for yourself. Recognize that individual monthly figures can be distorted, for example by seasonal trading. Rewarding yourself for good performance is better done after one year’s trading; in discussion with your accountant; and in consideration of the tax effects.

Business start-ups have a high failure rate. Some of these will be poor business ideas which were not viable in the first place. Much the larger number will fail because the entrepreneurs have neglected the financial planning recording and monitoring of their businesses. So to take steps to avoid that unpleasant winding up petition, begin with systematic approach to monitoring, then you can minimize the risk of failure, and reduce its effects if it does happen.

As Your Business Grows

As your business grows you will need to ensure that you keep things in order. The key to a successful business is effective management on all levels and keeping on top of the books is one of the aspects that create the biggest headaches in the early days. This need not be the case now, gone are the days of heavy ledger books and endless tapping on the calculator, the internet is now bursting with bright, user friendly bookkeeping packages with more features than the average small business could ever need. Choosing the one that fit’s the needs of your business should be your main influence along with the ease of use and compatibility with other technology.

By keeping clear bookkeeping records, you will be able to monitor all aspects of the financial status of your business which will be particularly relevant in ensuring that you remain tax compliant especially as your turnover draws near to the VAT Registration Threshold, which is currently £83,000 and for ensuring that your business can afford to take on staff.

Bookkeeping Software

There are packages on the market now to suit just about every budget and manage everything from the basic day to day bookkeeping through to robust reporting and analysis tools. The latest trend is moving away from the desktop and into the cloud offering access from your PC and through smartphones. So how do you decide which is the best option for you? For the tech savvy small business owner on the go a package that offers a solid mobile app that can handle the everyday functions such as invoicing and recording expenses will prove to be an administration asset, couple this with an on the go payment processing app such as iZettle and you can virtually manage most things from the palm of your hand. For those who prefer the big screen option then there are no end of choices there too.

Most providers offer the opportunity of a free trial, usually one month, make the most of this and if time allows trial several simultaneously, this will allow you to evaluate them clearly using identical data, by the end of the month you will probably find that you are only working with one package, the one that works best for you!

The other big advantage linked to cloud based packages is the ability to share information in real time, this can be valuable if you find you need assistance.

Taking on employees

As time goes on you may find that you need to take on an employee to assist with some aspects of the business. It is vital that you manage this correctly as failing to do so will result in penalties and fines.

When you decide that your business is ready to take on an employee you will need to ensure that the correct processes are followed, in the majority of cases you will need to be registered as an employer with HMRC and report your payroll information in real time using appropriate software. Most Accountants will be happy to offer compliant payroll services. Don’t forget to take into account your responsibilities in terms of your employee’s eligibility to work in the UK and so forth. You can use background checking services such as uCheck in order to ensure you are aware of anything that may have appeared on their criminal record.

You will also need to ensure that you clearly understand your obligations as an employer, employment law is complex and the penalties for employers in breach can be astronomical, one of the best resources for employers is Acas, originally set up by the government in 1896 as a voluntary conciliation and arbitration service, Acas have now separated from the government and now give advice to 800,000 callers per year with respect to employment related questions, resolving disputes and promoting good practice through their training courses.

VAT

As mentioned previously, the current VAT Registration Threshold is £83,000, put simply, this means that once your business turnover reaches this level within any 12 month period you should register for VAT. This is compulsory. In some cases, it may be advantageous to register voluntarily before you reach this level, this is particularly beneficial if your business sells a high volume of zero rated or exempt goods such as Children’s clothing and certain cold foods for example, in this instance you would then be able to reclaim VAT on eligible expenses.

When to register

If you are registering voluntarily then you may do this at any time; however you should take appropriate advice to ensure that it would be clearly in the best interests of your business to do so.

If you have reached the VAT Registration Threshold then you must, by law, register for VAT within 30 days of your business exceeding the threshold, if you register late then you must pay the VAT from the date from which you should have been registered, and HMRC may also add an additional penalty depending upon how late the registration was notified and how much VAT was due.

Managing VAT

Once registered for VAT you will need to complete and submit your VAT Returns, usually every 3 months. You should ensure that your returns are correctly calculated and that all records are kept in order.

You may wish to instruct your Accountant to manage your returns.

Auto Enrolment

Auto enrolment is a huge change in the employment landscape for UK businesses, yet many business owners and employers haven’t even heard about workplace pensions and have no idea what automatic enrolment is. It has long been recognised that most people are not saving enough for retirement and, as a result may not be able to afford to live comfortably in their retirement on just the State Pension. As people are also living longer, there is increasing strain on the State benefits system, so private pension provision is becoming increasingly important.

In order to encourage workers to start building up retirement benefits, pension reforms were introduced by the Government through the Pensions Act 2008 that requires all employers to offer workplace pension schemes and to enrol eligible workers into their schemes. These reforms have become known as automatic enrolment.

The reforms recognise that not all workers are eligible for automatic enrolment and that others, such as the self-employed, do not qualify. Provision has been made to allow those who fall outside of automatic enrolment to also join pension schemes and start building retirement benefits.

Automatic enrolment has been designed so that eligible workers who want to build up retirement savings don’t have to take any action themselves – employers will automatically enrol eligible workers into a workplace pension scheme and deduct any contributions that the member is required to pay from their wages or salary, and then pay into the pension scheme on their behalf.

What an employer must do

Your first step as a new employer should be to clarify your staging date. This is the date from which your Auto Enrolment reporting responsibilities will begin. You will need your employers PAYE References and details of your employee’s annual pay.

You will need to provide The Pensions Regulator with the contact details of the most senior person within your business as the nominated primary contact, you can also nominate a secondary contact. This should be someone who will be assisting in the implementation of the workplace pension in your business such as your payroll service provider or Accountant.

Auto enrolling your employees on time is vitally important and you should then submit a declaration of compliance to The Pensions Regulator. Employers must not try to coerce employees into not enrolling in the pension scheme.

This could be in the form of acting to discourage existing employees from auto enrolment or making it clear when hiring new employees that those who wish to be auto enrolled will be considered unfavourably.

Penalties for non compliance

If you do not comply with statutory notices, you may be issued with a fixed penalty notice. These types of penalties are set at £400.

The Pensions Regulator is also authorised to issue an escalating penalty. These types of penalties will vary depending on the number of staff you employ, for example, if you employ a high number of staff then the penalty will be much higher, with these penalties ranging from £50 to £10,000 per day.

The Pensions Regulator also have at their disposal an alternative the civil penalty. This penalty may be utilised if you fail to pay the contributions that you owe your staff when they contribute to their pension scheme. This penalty can be up to £5,000 for individuals, for example, business owners or managers. There can also be fines of up to £50,000 for the company itself.

The final option that The Pensions Regulator can call upon is the ‘Prohibited Recruitment Conduct Penalty Notice’. The severity of this penalty varies depending on how many staff are employed in the company and can range from £1,000 to £5,000.

The Pensions Regulator can and will initiate formal legal proceedings to recover penalties that businesses and employers have been issued with. Employers who are found to have breached their duties also face criminal prosecution.

Which employees need to be enrolled?

You will need to assess your employees to confirm who needs to be enrolled. The assessment can either be done manually or automatically using business software and will need to be carried out each time the workforce changes for example if a new employee joins or somebody has a birthday.

If you are using business software (for payroll, HR and pensions administration), this could be set up to automatically assess and monitor staff ages, earnings and pension contributions paid into a pension scheme both by members of staff and yourself. If you don’t, the table below shows how to assess staff based on their ages and how much they earn.

*State Pension Age

Employee has a right to join a pension scheme
If they ask, as an employer, you must provide a pension scheme for them, but you do not have to pay contributions into a pension scheme on their behalf.

Employee has a right to opt in
If your employee asks to be put into a pension scheme, you must put them in a pension scheme that can be used for automatic enrolment and pay regular contributions.

Employee must be enrolled
You must put these members of staff into a pension scheme that can be used for automatic enrolment and pay regular contributions. You do not need to ask their permission. If a member of staff gives notice, or you give them notice, to leave employment before you have completed this process, you then have a choice whether to enrol them or not. The employer also has a choice whether to enrol a director who meets these age and earnings criteria.

It is strongly advised that you take independent advice when setting up your pension scheme. You must bear in mind that most Certified and Chartered Accountants are not qualified as Financial Advisors and so whilst they may be able to help in the setting up and running of your Auto enrolment pension scheme they are not generally qualified to give advice concerning which pension provider you should use, in fact, unless they hold a suitable and current IFA qualification they would be in breach of the law in providing such advice.