The type of tax and the rate you pay will depend on how your business is structured, whether it employs staff and what its turnover is.
If you're a sole trader, you will pay income tax on your earnings. This means that you could end up paying higher rate tax, or even top rate tax, on a substantial proportion of your profits. As a result, this structure is probably not the most tax-efficient one for businesses with a turnover of £50,000 or more.
Sole traders need to register for self-assessment with HMRC and file an annual self-assessment tax return. They can do both online.
Sole traders pay fixed-rate Class 2 National Insurance contributions and will normally have to make additional Class 4 National Contributions if their profit in 2012-13 exceeds £42,475.
Each partner must file their own annual self-assessment tax return with HMRC and pay National Insurance contributions and income tax on their share of the profits. One nominated partner must also send a partnership return to HMRC.
Companies with profits of less than £300,000 pay corporation tax at the small profits rate of 20%; companies with greater profits pay the main rate of corporation tax, which is 24% in 2012/13, 23% in 2012/13 and 22% in 2013/14.
Tax codes consist of several numbers and a letter, for example: 117L or K497. The letters relate to the taxpayer's personal circumstances. For example, if the letter L appears in a tax code, it means the employee is eligible for the basic personal allowance in 2012/13. The number in the tax code relates to the employee's personal allowance - ie how much they can earn in a tax year before paying tax.
Employers must operate a Pay as You Earn (PAYE) scheme for their staff, which involves them deducting tax and employee Class 1 National Insurance contributions from their employees' pay and paying additional employer's Class 1 National Insurance contributions. As a result, they need to calculate their employees' tax codes. They should follow this method:
- Add up all the special allowances the employee is entitled to (for example, blind person's allowance);
- Add up all the income that has not had tax paid on it (for example, bank account interest) and taxable employment benefits (for example, health insurance);
- Deduct the total income the employee has not paid tax on from the total amount of tax allowances. The remainder is the total tax-free income that the employee is allowed in a tax year.
- Divide the total tax-free income by 10 and add it to the letter most appropriate to the employee's circumstances.
HMRC publishes the rates and thresholds for employers to use when calculating National Insurance contributions on its website.