Effective business planning

Starting a new business

Starting a new business venture is a risky proposition, whatever the economic climate. There are a number of factors to consider, including: the nature of the business; your target market and competitors; the potential for profit; how you will extract those profits; how fast the business will grow; how the business will impact on your life; the potential risks involved; and how you plan to exit the business.

Business plan: A comprehensive business plan is essential. This should include: your sources of funding; tax-efficient borrowings; whether the business needs a PAYE scheme or to be VAT registered; and, not least, the business structure that will best meet your needs (sole owner, partnership, limited liability partnership or limited company). We can help you through the decision-making process – and to make the appropriate registrations. A good cash flow forecast can help you spot potential times when cash will be short, and regular updates will help you to see how your business is performing.

Business structure: There are both advantages and disadvantages for each trading structure and each has implications for control, perception, support, and costs. For example, careful consideration is needed regarding whether or not to retain personal ownership of any freehold property on an incorporation of business.

Choosing a year end: It is also important to choose the right year end for your business. Is there a time of year when it will be more convenient to close off your accounting records, ready for us? What would be the best time of year for stock-taking? To what extent is your business seasonal? From a tax viewpoint, the choice of a year end early in the tax year for an unincorporated business usually means that an increase in profits is more slowly reflected in an increased tax bill and over time the delay between earning profits and paying the tax can create a source of working capital for the business. Conversely, a reduction in profits will more slowly result in a lower tax bill.

HMRC registration: Advising HMRC when you become self-employed, and probably liable to Class 2 national insurance contributions (NICs), may not be very high on your list of priorities in the first weeks and months of a new business – but failure to notify will attract a penalty if tax or NICs are unpaid as a result. You should register as soon as possible to begin paying NICs and notify HMRC of your new self-employed status.

Regional employer NICs holiday for new businesses

This is a scheme intended to assist new businesses in targeted areas of the UK. Within a three year qualifying period, employers eligible for the scheme will not have to pay the first £5,000 of Class 1 employer NICs due in the first 12 months of employment. This will apply for each of the first 10 employees hired in the first year of business.

The targeted countries and regions are: Scotland, Wales, N.Ireland, the North East, Yorkshire and the Humber, the North West, the East and West Midlands and the South West.

Reminder
The standard rate of VAT will rise to 20% with effect from
4 January 2011. A consequence of the standard rate change is that the flat rate scheme rates have also been revised. You therefore need to check what your new rate will be. 

Claiming deductible expenses

Our role is to work with you to minimise your taxes, and it is important to take advantage of all the opportunities available.

You will pay tax on your taxable profits, so it is essential to claim all deductible expenses, many of which will be included in your accounting records. If you are self-employed and carry on your business from home you can claim tax relief on part of your household expenses, including insurance repairs and utilities.

You can also claim for the cost of travel and accommodation when you are working away from your main place of business. You must keep adequate business records – including a log of business journeys – because in addition to ensuring your accounts are accurate, these records may be requested by HMRC.

Have you considered using an appropriate computer package for record keeping?

Your business and capital allowances

‘Capital allowances’ is the term used to describe the deduction we are able to claim on your behalf for expenditure on business equipment, in lieu of depreciation.

Annual Investment Allowance (AIA): The first up to £100,000 of the year’s investment in plant and machinery, except for cars, is allowed at 100%. This applies to any size of business and most business structures, but there are provisions to prevent multiple claiming. Businesses are able to allocate their AIA in any way they wish; so it is quite acceptable for them to set their allowance against expenditure qualifying for a lower rate of allowances (such as long-life assets or integral features) – see below.

The maximum AIA increased with effect from 1 April 2010 (corporates) or 6 April 2010 (others). If an accounting period straddles the “operative date”, the maximum AIA for the transitional chargeable period is the sum of:

• the AIA entitlement, based on the previous £50,000 annual cap for the portion of a year falling before the relevant operative date; and
• the AIA entitlement, based on the new £100,000 cap for the portion of a year falling on or after the relevant operative date.

Thus a company with a calendar year chargeable period from 1 January 2010 to 31 December 2010 would calculate its maximum AIA entitlement based on:

(a) the proportion of a year from 1 January 2010 to 31 March 2010, that is, 3/12 x £50,000 = £12,500; and

(b) the proportion of a year from 1 April 2010 to 31 December 2010, that is 9/12 x £100,000 = £75,000.

The company’s maximum AIA for this transitional chargeable period would therefore be the total of (a) + (b) = £12,500 + £75,000 = £87,500.

Once established, the maximum entitlement can be spent at any point in the 12 month period, with one restriction, that only expenditure up to £50,000 will qualify before 1 April 2010.

Note that the maximum AIA reduces to £25,000 with effect from April 2012.

Special rules which may disallow property loss relief against general income to the extent that the loss is attributable to the AIA are now in force. This provision will only apply where there are relevant tax avoidance arrangements. Contact us for more details.

Enhanced Capital Allowances (ECA): In addition to AIA, a 100% first year allowance is available on energy saving or environmentally beneficial equipment. Where companies (only) have losses arising from ECAs, they may choose how much they wish to carry forward and how much they wish to surrender for a cash payment (tax credit payable at 19%).

There is a separate ECA scheme for electric and low CO2 emission (up to 110 g/km) cars, zero-emissions goods vehicles (the last proposed, for five years from 1 April 2010 (corporates) or 6 April 2010 (others)) and natural gas/hydrogen refueling equipment. They still qualify for the 100% first year allowance, but do not qualify for the payable ECA regime.

Writing Down Allowance (WDA): Any additional expenditure not covered by the AIA (or enhanced capital allowances (ECA)) level enters either the main 20% pool or a special 10% pool, attracting WDA at the appropriate rate. These rates are set to reduce to 18% and 8% with effect from April 2012. The special rate 10% pool applies to long life assets, the addition of thermal insulation to existing commercial buildings, and integral features of buildings, specifically:

• Electrical systems (including lighting systems)
• Cold water systems
• Space or water heating systems, powered systems of ventilation, air cooling or purification and any floor or ceiling comprised in such systems
• Lifts, escalators and moving walkways
• External solar shading
• Active facades (climate-responsive features).

The 20% pool applies to most other plant and equipment, including some cars (see below).

Businesses may claim a WDA of up to £1,000 where the unrelieved expenditure in the main pool or the special rate pool is £1,000 or less.

Cars: A rate of 20% applies to cars with CO2 emissions exceeding 110 g/km. However, cars with CO2 emissions above 160 g/km will be restricted to 10% WDA. Expenditure incurred before April 2009 on “expensive” cars continues under the old regime (£3,000 per year cap on capital allowances). For non-corporates, cars with a non-business use element continue to be dealt with in single asset pools, so the correct private use adjustments can be made but the rate of WDA will be determined by the car’s CO2 emissions.

Buildings: The phased withdrawal of industrial and agricultural buildings allowances continues during 2010/11 with essentially a further reduction in the WDA by 50%. If a trader obtained 2% allowance previously, the allowance is now 1%, subject to transitional rules.

A maximum 100% initial allowance is available for conversion of parts of business premises into flats, business premises renovation allowance and Enterprise Zone Allowance. WDA of 20% applies to expenditure on which an initial allowance is not claimed.

Research and Development relief

Tax relief is available on research and development (R&D) revenue expenditure at varying rates. Maximum rates of relief for 2010/11 are as follows:

• For small and medium-sized companies paying tax at 21%, the maximum rate of tax relief is 36.75% (that is a tax credit on 175% of the expenditure)
• For small and medium-sized companies not yet in profit, the relief can be converted into a tax credit payment worth 24.5%
• For larger companies paying tax at 28%, the maximum rate of relief is 36.4% (that is a tax credit on 130% of the expenditure).

This is subject to a minimum annual spend of £10,000. SME relief is capped at £7.5 million per project and subject to the most recent accounts having been prepared on a going concern basis.

SMEs barred from claiming SME R&D tax credit by virtue of receiving some other form of state aid (usually a grant) for the same project will be able to claim the large company R&D tax credit. This means that they will qualify for relief on 130% of their R&D expenditure.

Employing family members

You can employ family members in your business, provided the package is commercially justifiable. You can remunerate family members with a salary, and perhaps also with benefits such as a company car or perhaps medical insurance – and you can make payments into a registered pension scheme.

An alternative to a company car is to provide a van: the maximum annual tax bill on the use of a company van with unlimited private use is only £1,500 or £1,775 including free fuel.

You can also take family members into partnership, thereby gaining more flexibility in profit allocation. In fact, taking your non-minor children into partnership and gradually reducing your own involvement can be a very tax-efficient way of passing on the family business. Be aware that taking family members into your business may put the family wealth at risk if, for example, the business were to fail.

HMRC may challenge excessive remuneration packages or profit shares for family members, so seek our advice first. If you operate your business through a trading limited company, under current tax law you can pass shares on to other family members and thus gradually transfer the business with no immediate tax liability in most cases. However, a tax saving for the donor usually impacts on the donee, and you need to steer clear of the ‘settlements legislation’, so again, seek our advice first.

Unincorporated businesses

Business profits are charged to income tax and Class 4 NICs on the current year basis. This means that the profits ‘taxed’ for each tax year (ending 5 April) are those earned in the accounting period ending in the tax year.

Case Study 1

Mary, a sole trader, draws up her accounts to 31 July each year. Her profits for the year ended 31 July 2010 will normally be taxed in 2010/11.

There are special rules for the early and final years of a business, and for partnership joiners and leavers. There is a growing number of ‘fines’ for those not complying with the rules and regulations of Government departments. We have already mentioned income tax and Class 2 NICs, but other ‘traps’ to avoid are:

• Late VAT registration
• Late filing penalties
• Late payment surcharges and interest
• Penalties for errors in returns
• Penalties for failing to operate a PAYE or sub-contractors scheme

If we are to help you to steer clear of these traps, you must let us have all the details for your accounts and Tax Returns in good time, and inform us of any changes in your business, financial and personal circumstances.

Determining your employment status

There is no statutory definition of ‘employment’ or ‘self-employment’. Rather, there is a series of ‘tests’ which HMRC will apply to ascertain whether someone is classified correctly.

Because large amounts of both tax and NICs can be at stake, HMRC can take quite an aggressive line and mistakes can cost you dearly, so advice specific to your situation is essential.

‘IR35’ rules require businesses to consider each and every contract they enter into for the provision of services. The test is whether or not the contract is one which, had it been between the owner or partner and the customer, would have required the customer to treat the owner or partner as an employee and therefore be subject to PAYE.

The contract ‘passes’ if the owner/partner would have been classified as self-employed; it fails if the owner/partner would have been classified as an employee.

If the contract ‘fails’, the business is required to account for PAYE and NICs on the ‘deemed’ employment income from the contract at the end of the tax year.

This is done using specific rules. We would welcome the opportunity to advise you about these.

Unpaid invoices and unbilled work

It is a feature of the tax system that businesses must include in their turnover for the year the value of incomplete work, of unpaid bills (debtors) and of work completed but not yet billed, all as at the end of the year. This was not always the case, and thus HMRC has been ‘catching up’.

We will need to discuss with you exactly what needs to be identified and the basis of valuation. And whether you are starting a new business or running a more mature business, keeping an eye on debtors and unbilled work is crucial to your cash flow.

Forming a limited company

You could form a limited company if the limitation of liability is an important consideration – but do bear in mind that banks and other creditors often require personal guarantees from directors for company borrowings.

Trading through a limited company can be an effective way of sheltering profits. Profits paid out in the form of salaries, bonuses, or dividends may be liable to top tax rates, whereas profits retained in the company will be taxed at rates from as low as 21% (20% from April 2011).

Retained funds can be used to buy equipment or to provide for pensions – both of which are eligible for tax relief. They could be used to fund dividends when profits are scarce (spreading income into years when you might be liable to a lower rate of income tax?) or capitalised and taxed at 10% or 18%/28% on a liquidation or sale. Forming a partnership with your own limited company or introducing limited partners into your partnership or limited liability partnership (LLP) can create tax-saving opportunities.

An increasing number of businesses have incorporated, or introduced limited partners, but there are important implications which we would be happy to discuss with you, before you decide whether or not to incorporate your business.

National insurance: your liability

Although leaving profits in the company can be tax-efficient, you need money to live on, so you should consider the best ways to extract profits.

A salary will meet most of your needs, but do not overlook the use of benefits, which may save income tax and could also result in a lower national insurance liability.

Six ways to save NICs:

• Increasing the amount the employer contracts to contribute to company pension schemes (subject to allowance not being exceeded)
• Share incentive plans (shares bought out of pre-tax and pre-NIC income)
• For companies, disincorporation and instead operating as a sole trader or partnership
• Instead of more salary, paying a bonus to reduce employee (not director) contributions
• Paying dividends instead of bonuses to owner-directors
• Provision of childcare and other tax-free benefits.

Owner-directors: increasing net income

As an example, consider how much you might save if, as an owner-director, you wanted to extract the £10,000 profit (pre-tax) your company makes in 2010/11 by way of a dividend rather than a bonus.

Case Study 2

As you can see in this case study, the net income is increased by more than 13% by opting to declare a dividend. Be sure to discuss this with us, as this is a complex area of tax law. 

Please note that in Case Study 2 we assume that you are paying higher rate tax at 40%, and that your earnings exceed the so-called ‘upper limit’ for NICs. There are many matters to be considered when deciding whether directors should be paid by dividend or salary/bonus. In practice, a combination of each is often an appropriate course.

Remember that dividends are usually payable to all shareholders. Although it is possible to waive dividends, this can result in tax complications, so a better option may be to have different classes of share. Finally, you need to consider with us the effect of regular dividend payments on the valuation of shares in your company.

Planning ahead of the year end

Tax and financial planning should not be left until the end of the tax or financial year, but in advance of the end of YOUR business year. Issues to consider include:

• The impact on your tax position and financial results of accelerating expenditure into the current financial year, or deferring it into the next
• Additional pension contributions or reviewing your pension arrangements
• How you might take profits from your business at the smallest tax cost, and how the timing of payment of dividends and bonuses can reduce or defer tax
• Avoiding overvaluing stock and work in progress
• Improvements to your billing systems and record keeping, or a general systems review to improve profitability and cash flow
• National insurance efficiency and employee remuneration packages with potential cost savings for both you and your employees.

Tax payment dates

The timetable of tax payments is relatively straightforward for the self-employed.

• 31 January in the tax year, first payment on account
• 31 July after the tax year, second payment on account
• 31 January after the tax year, balancing payment

There is also a system of interest and surcharges to encourage prompt payment.

For example, if you do not make your full 2009/10 balancing payment by 28 February 2011, HMRC will add a 5% surcharge as well as the interest that will be charged from 1 February 2011. Delay until after 31 July 2011, and a further 5% surcharge in addition to the interest will be added. In addition interest is charged on outstanding surcharges, as well as on unpaid tax and NICs.

If you have incorporated your business the company will be paying corporation tax. Corporation tax is normally payable nine months and one day after the end of the accounting period.

If cash flow is tight, HMRC could be persuaded to accept a spreading of your next business tax payment – you will have to pay interest at the HMRC rate, but keep to the agreed schedule and surcharges will be waived. Arrangements need to be put in place before the due date for paying the tax, so talk to us in good time if you need or wish to apply.

Reducing payments on account

Payments on account are normally equal to 50% of the previous year’s net liability. A claim can be made to reduce your payments on account, if appropriate, although interest will be charged if your actual liability is more than the reduced amount paid on account.

Do not wait until it’s too late – please keep us informed of any factors which might affect your tax liability.

We can only suggest business solutions if you tell us in good time about any issues facing your business.

Payments on account will not be required where the net liability does not exceed £1,000, or where the self assessment tax/NIC is less than 20% of the previous year’s total income tax/Class 4 NIC liability (instead, the full liability is due on 31 January after the tax year).

Case Study 3

Isabelle is self-employed. Her accounts are made up to 31 August each year. When we prepare the 2010 Return we will be including her profit for the year ended
31 August 2009, and that is the profit which will be taxed for 2009/10.

Isabelle’s payments on account for 2010/11 will automatically be based on the 2009/10 liability.

If we know that Isabelle’s profits for the year to 31 August 2010 are significantly less than the previous year, we can discuss the figures, perhaps even prepare the annual accounts, and make a claim to reduce Isabelle’s 2010/11 payments on account, easing her cash flow by reducing the tax payments due in January and July 2011.

Looking ahead:

NIC rates are due to rise from April 2011:
 

 Contact us for advice on:

• Starting up and obtaining finance
• Timing capital and revenue expenditure to maximum tax advantage
• Minimising employer and employee NIC costs
• Improving profitability and developing a plan for tax-efficient profit extraction

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