INCOME TAX

What is income tax?

Income tax is a direct tax which is levied on the income of private individuals. Taxable income includes wages, salaries, investments, interest, dividends, benefits and any income from self-employment.

How will you be taxed?

The way you will be taxed will depend on the legal form of your business and the way you run your business. You will be taxed differently if you define your employment status as ‘self-employed’ or ‘employed’. For example, in the case of a couple, if the husband had set up as a sole trader, he would be regarded as self-employed while his wife may be regarded as employed. If the same couple set up their business as a limited company, they would both be regarded as being employed by the business.

Income tax for employees

Employees will be taxed at the prevailing rates, normally through the PAYE (Pay As You Earn) system, where the employer deducts tax and National Insurance payments from wages or salary payments. Everyone must keep a record of their income for a minimum of 22 months after the end of the tax year.

The company is also required to provide an employee with the following:

• itemised wage slips;
• an annual P60 (showing total earnings);
• an annual P11D (summarising any taxable benefits).

Income tax for directors

Directors must also complete a self-assessment tax return, giving details of salary, fees, divided payments and any other taxable benefits like a company car.

Registering as self-employed

If you are self-employed, you must register with HM Revenue and Customs within 3 months of starting up. This includes sole traders and standard partnerships. They will register you as self-employed and arrange for you to pay the correct National Insurance contributions (see below).

Income tax for the self-employed

If you are self-employed, you should automatically receive a tax return at the end of the tax year (5 April). If you are not sent one, it is your responsibility to obtain one. There are penalties for missing the deadline for returning the form, or not paying tax that you owe.

If you are self-employed, which includes sole traders and partners in a standard partnership, you pay tax on your business profits or your share of the profits and not on the amount of money you pay yourself (ie your ‘drawings’). You will also be taxed on any other income you earn, for example, salary or wages from any other work, interest on savings and dividends from shares. You may also be taxed on the disposal of certain assets. You will be able to claim allowances that reduce the amount of tax you pay dependent on your circumstances. These tend to be reviewed annually and can be found on the HM Revenue and Customs website.

You are required to keep accurate records of all your business transactions including any amounts you have paid into or taken from the business. Purchases and expenses need to be supported by invoices, unless they are for small amounts. By law, you are required to keep your business records for at least 5 years and 10 months after the end of the tax year.

Income tax for partnerships

Business partners in a standard partnership are normally regarded as self-employed, but income tax is applied in a slightly different way than in the case of a sole trader. As a partner, you pay tax and National Insurance on your share of the partnership’s profits. The arrangement for sharing profits should be clearly stated in your partnership agreement; it is not necessarily the case that profits are split equally between partners. Profit sharing may be based on factors like levels of investment or time spent running the business.