The UK Tax System Simplified
The UK System is one of the most complex legislations in the world and it is understandable why so many people feel like going to sleep when someone starts talking about how it works! However, as you know as a construction business owner you do need to know about it…
His Majesty's Revenue and Customs (HMRC) is responsible for the collection of taxes for the Government. As a construction business owner, there are 5 main taxes you should be familiar with; Corporation Tax, PAYE, VAT, CIS and Self-Assessment.
Corporation Tax is the type of tax used on a limited company's profits for the financial year. A Financial Year is a period of 12 months for a business. The main corporation tax rate is 19%, in April 2023 this will be increased for businesses with profits above £50,000.
There are many strategies for reducing your corporation tax and it usually happens by spending in the right areas so it is weighing up the cashflow over the reduction of tax. Each year limited companies are required to submit statutory accounts with an accompanying tax return.
Corporation tax is required to be paid 9 months and 1 day after the end of the financial year.
Pay As You Earn (PAYE) system is HMRC's method of collecting income tax, national insurance and repayments of students loan at the source. This means it is the employer's responsibility to deduct the relevant tax and national insurance and pay this amount to HMRC by the 22nd of the following month.
Typically there will be income tax, employee national insurance and employer national insurance that will need to be paid. If you have two or more employees you will be eligible to claim the Employment Allowance which can be used to offset the employer's national insurance payable.
If you are registered for VAT you will be required to submit VAT returns to HMRC every quarter. If your turnover exceeds £85,000 you are required to register for VAT.
When you are VAT registered you will need to charge VAT at 20% on your invoices, for any purchases you make you are allowed to claim the VAT element back if it is stated on the invoice such as on materials. The VAT collected from clients and VAT paid on materials is offset against each other (VAT on sales less VAT on purchases) this will give you your VAT liability for the quarter. This is required to be paid one month and seven days after the end of the VAT Quarter.
If you have a Direct Debit set up with HMRC, you will have 3 additional days for the payment deadline.
If you are working for contractors under the Construction Industry Scheme then a special type of VAT is charged, Domestic Reverse Charge. When this is used it is now the contractor's responsibility to declare and reclaim the VAT element. This is HMRC's way of reducing VAT fraud in the industry. This can be confusing so it could be beneficial to work with construction specialised accountants and bookkeepers!
The two most common VAT schemes construction businesses use to submit their VAT return is VAT Cash Accounting Scheme and VAT Accrual Scheme.
If you use VAT Cash Accounting Scheme, you only pay/reclaim VAT on sales and purchases that have been paid for in the quarter.
For the VAT Accrual Scheme, you will include invoices based on their invoice date (tax point), it does not matter if the invoice has been received/paid, you are still required to pay the VAT if it falls within the relevant quarter.
As briefly mentioned before with Domestic Reverse Charge, the Construction Industry Scheme (CIS) is HMRC's method of reducing tax fraud in the industry. CIS is a scheme for deducting income tax/corporation tax from subcontractors at source.
As a contractor, you will have additional responsibilities, if you are carrying out work that falls within CIS you are required to verify all subcontractors that work for your business. When you verify a subcontractor using HMRC system you will be told what percentage you will need to deduct for CIS from a subcontractor's invoice.
There are three results for a CIS verifications:
- Gross Status - This means a subcontractor has applied with HMRC to not be deducted CIS (conditions have to be met). Gross Status is 0% deduction
- Standard Status - If a subcontractor has registered with HMRC to be a subcontractor they will have this status which is typically the most common result. You will be required to deduct 20% from a subcontractors invoice
- 30% deduction - If a subcontractor has not registered with HMRC as a subcontractor, you will be required to deduct 30% from a subcontractor's invoice.
This is very important because as a contractor you are required to before a CIS verification before paying any subcontractors.
At the end of every tax month (5th to 6th) you will be required to complete a CIS Return, this shows how much CIS has been deducted from each subcontractor. The amount deducted has to be paid to HMRC by the 22nd of each month.
Once a CIS Return has been submitted, you are required to send all subcontractors a Statement of Payment and Deductions which they will use for their records at the end of the tax year.
Self-Assessment is the method used to declare and pay any personal tax i.e the amounts extracted from your limited company through salary, dividends or other interest etc.
The tax year for self-assessment runs from 6th April to 5th April and does not correspond with your limited company financial year. The online deadline for filing your self-assessment is the 31st of January following the end of the tax year.
If your personal tax liability exceeds £1,000, you will also be required to make payments on account which is basically paying for your tax bill in advance. This is 50% of your tax liability paid on the 31st of January and 31st of July.
5th April 2022 to 6th April 2023
Your first payment on Account would have been paid on 31st January 2023 which is 50% of your tax liability from your previous self-assessment.
Your second payment on Account would be on 31st July 2023 with the remaining 50%
On 31st January 2024, you will pay any extra tax if required and again the cycle will start again paying your first payment on account for the following tax year.
You are taxed at different rates depending on whether you are a basic rate of 20%, higher rate of 40%, or an additional rate taxpayer of 45% respectively for income tax.
The Dividend Tax Rates are; basic rate at 8.75%, the higher rate at 33.75% and the additional rate at 39.35% for dividend tax for the 2022/23 tax year. In addition to the personal allowance, the first £2,000 dividends that you take within the tax year are tax-free.
It is usually recommended to take a salary/ dividend split to take advantage of the personal allowance and dividend tax rates.
The personal allowance is a tax free allowance so for 2022/23 the personal allowance is £12,570. Anything above the personal allowance is charged at the relevant tax rates depending on what type of income it is.
There is a common misconception that you are paid more if you earn £12,569 than on £12,571. This is not the case as you only pay tax on the amounts earned above the tax-free threshold – so if your salary was £12,571 then you would be taxed on £1 at 20% meaning you would have to pay 20p of income tax.
There is a common misconception that if you are paid £12,569 you would earn more money than if you are paid £12,580. The personal allowance will still apply in full as tax free even if you go over that amount. Any in excess of that amount is charged to tax so say for income tax and you earned £12,580 - £12,570 would be tax free so charged at 0%, the following £10 would be charged at 20% which would be £2 in tax.
Frequently asked questions
This article has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.
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