There’s been a lot of talk recently about how the great new lifeblood of the UK - and worldwide - economy is going to be fuelled by small businesses. Emily Coltman, chief accountant to FreeAgent, looks at how the UK's tax rules might be holding back the country's emerging businesses.
Will the UK's regulation-heavy tax environment hinder small businesses? Emily Coltman believes so. Image courtesy of: Woodsy/RGB Stock
The UK Government is actively encouraging start-up businesses, while major high street banks such as RBS
are providing specific packages designed to help fledgling ventures get off the ground and prove successful in the current economic climate.
It’s a great idea in theory - this notion that entrepreneurial flair will flourish as the skills of new business owners and service providers sweep through the marketplace. But although Westminster would dearly love to see thousands of successful new businesses being created throughout the country every day to drag the economy out of its downturn, the reality is that many of these businesses will be hindered by the UK’s draconian tax rules and regulations.
Even the very smallest sole trader or freelancer whose profits are below £5,000 per year has to think about income tax - and if their profits exceed this, then they have to take Class 2 and Class 4 National Insurance into account as well.
Tax is a complex issue, for sure, but there are times when it is too complicated - certainly when it comes to running micro-businesses. At the moment, tax rules can be very intricate and business owners may find it confusing when trying to adhere to all of the various rules and regulations that they have to meet when filing their tax return.
The main problem is that there are just too many taxes for small business owners to try and stay on top of. For example, even the very smallest sole trader or freelancer whose profits are below £5,000 per year has to think about income tax - and if their profits exceed this, then they have to take Class 2 and Class 4 National Insurance
into account as well.
If the business grows further, you have to work out whether you are required to pay VAT - and try to get to grips with the multitude of rules and requirements for VAT registration and assessment. And, of course, if the business takes on any employees, then there’s also PAYE and Class 1 National Insurance to consider, as well as the National Minimum Wage.
To further complicate matters, if your business is a limited company, it pays corporation tax on its profits instead of income tax and Class 4 National Insurance, and you’ll no longer need to pay Class 2 National Insurance. The company is your employer, so if you’re drawing a salary from the company there will be PAYE and Class 1 National Insurance to consider. Changing to this can be challenging if you’ve been used to running your business as a sole trader.
Furthermore, every one of these individual taxes are complicated in their own right - and all of them have wrinkles and issues to contend with, which can be very counter-intuitive. For example, many small business owners will travel during their work and will claim expenses back on this travel. However, road tolls are outside the scope of VAT if they're operated by a public authority, but standard-rated (20 percent) if they're privately operated.
For small business and freelancers in particular, this myriad of tax rules is an unwelcome distraction from the day-to-day necessities of actually running their business. Most of them are - quite rightly - more concerned with providing the best product or service possible, targeting new markets and seeing their sales numbers rising, rather than filling in overly complicated tax forms. Who wants to tear their hair out trying to figure out which expenses they should be claiming, or what restrictive rules they should be adhering to, when they are trying to keep their start-up business afloat?
The complex nature of the tax system may even be dissuading many would-be entrepreneurs and business owners from starting their own venture in the first place. After all, if you have to navigate miles of tax-related red tape - or pay a team of professionals to manage your accounts and tax calculations for you - then you’ll be less enthusiastic about getting your fledgling business idea off the ground.
There have been many rumblings in recent years about whether the UK tax system should be simplified. in 2010, Chancellor George Osborne even announced the setting up of a new body - the Office of Tax Simplification
- in order to streamline the tax code, but it still has not helped make the tax minefield any easier for small businesses to navigate.
There are still complicated tax rules around claiming certain expenses such as running costs of a home, or travelling, in addition to the difficulty of distinguishing when the business owner and the business are one and the same, and when they're not.
We also currently have a situation where limited companies and limited liability partnerships
(LLPs) have to deal with the complexity of company law - and where many businesses are constantly at risk of falling foul of complicated issues such as income tax, National Insurance, VAT, capital gains tax, corporation tax and PAYE compliance.
Hiring the help of a good accountant - so they can act as a “business minesweeper” when it comes to tax issues - can be a godsend and really help a small business or freelancer stay out of trouble. But wouldn’t it be better to have a system in place where microbusiness owners can manage the basic number crunching themselves, and instead utilise their accountants’ skills as trusted business advisors?
If the Government is truly committed to seeing a new generation of freelancers and small businesses leading the charge and taking the UK on the road towards economic recovery, it needs to provide some concrete support in order to help these businesses thrive. Simplifying the tax rules would certainly be a good start.
Emily Coltman ACA joined FreeAgent as its Chief Accountant in 2009. Passionate about very small business and keen to help small business owners have as few financial hassles as possible, Emily speaks two languages - accountantese and plain English. She published her ebook Finance for Small Business in August 2011. Emily graduated from Cambridge University in 1998 with an MA in Music and qualified as a Chartered Accountant in 2003.