The common perception is that tax planning involves complicated arrangements and structures that accountants or lawyers create to reduce the amount of tax you pay. This is not the case. Tax planning is available to everyone and the Government regularly introduces new legislation and allowances. Understanding how this might apply to your circumstances allows you to pay the right amount of tax, minimise your tax bill and comply with current rules.
It is important to point out the difference between avoidance and evasion of tax. Avoidance, utilising pension contributions and claiming the correct Expenses, is legal. Evasion, stashing money away and denying knowledge of it or claiming inappropriate Expenses, is illegal.
Good tax planning is about using the existing rules to structure your affairs in a tax-efficient way to your best advantage. In this section we look at best practice to optimise your tax position as a sole trader.
It is important to stress that this is general guidance and should not be relied upon in isolation as either tax or financial advice. Before choosing a course of action it is always advisable to seek a professional opinion, so your unique personal and business circumstances can be considered.
Reducing your tax liabilities
Ensure you claim all appropriate Expenses. Most expenses genuinely incurred in the course of your business are tax deductible. Tax relief is only due on expenditure incurred wholly and exclusively for the purpose of your trade. Remember to keep a record of all the expenditure incurred in the period prior to the date you actually commenced to trade if it was incurred in the setting up of the business.
Offset profit with Pension Contributions. It is possible to offset either some or all of your higher rate tax liability by making pension contributions, benefiting from the generous tax relief(s) available. If you believe that your net profit plus any other sources of income will take you over the higher rate threshold of £42,385 (for the year ending 5 April 2016), (check after budget) you will have a higher rate personal tax bill to pay once your self-assessment return is done. You can reduce or eliminate this liability with pension contributions.
Paying family as staff to help in the business for example, as an administration assistant, is a legitimate business expense. Their pay should be at a justifiable level for the work done. Payments should be made preferably by cheque or bank transfer. As long as this is an employment relationship and any payments to any one individual are less than £5,824 (2015/2016), assuming that they have no other income, there will be no tax or NI to pay.
When you make a Capital Purchase, it is included in your businesses’ balance sheet as a fixed asset. Capital items have historically not been allowable for tax in the same way as normal expenses. Deductions for the cost of the item for income tax are only given over a number of years however; recently the benefits have been generous.
There are some other issues that may affect your potential tax liability that are with consideration.
Capital Gains Tax
Capital Gains Tax (CGT) is generally charged on the profit you make when you sell, or give away, certain assets. These assets tend to be land and buildings, shares and business assets including goodwill.
Private Residence Relief
Private residence relief is the name given to the tax relief when selling your home, designed to ensure that most people don’t face a Capital Gains Tax (CGT) bill.
If you sell or close your business, you may be able to claim Entrepreneurs’ Relief. This means you only pay 10% Capital Gains Tax (CGT) on any qualifying profits, effectively reducing your tax liability.