Beginner’s Guide to United Kingdom Taxation System For Business Owners

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Published: September 24, 2021
Last Updated: February 13, 2025

Taxation, particularly in the United Kingdom, is a relatively complicated one. With our article, we will try to clear all your doubts about the UK taxation system. First and foremost, you need to understand the role of taxation authority. Tax payment may involve payments to at least three different government levels: the central government, devolved governments, and local governments in the form of council taxes. For most taxes, the central government HM Revenue and Customs (HMRC) is responsible for administering taxes. These taxes include income tax, corporation tax, capital gains tax, inheritance tax, insurance premium tax, environmental taxes, VAT, Customs duty, and excise duties. When we say devolved government, we are talking about Scotland, and here the tax bands are slightly different from rates in the rest of the United Kingdom. And lastly, the council tax in the UK is administered by the local government.

Taxation compliance can take time and effort, and an in-depth understanding of taxation for different industries and business structures. Thus, it will be helpful if we understand the business types and their tax implication. There are mainly three forms of business structure –

1. Sole trader
2. Partnership
3. Company

The structure you choose can affect the degree of your personal liability, the amount of administrative work involved, even your ability to raise finance, and most importantly, each structure has its own tax obligations. You must fulfil these obligations, and if you can’t put your time and effort to do so yourself, it is best to hire a taxation advisor.

1. Sole trader
If you run your own business as an individual and are self-employed, you have a sole trader business. A sole trader business is not a separate legal entity, and thus liabilities in case of business failure are unlimited. Registering a sole proprietorship is the easiest as compared to other business structures in the UK. You must register online for self-assessment to pay personal tax and National Insurance. After this, HMRC will set up your account for online assessment services after sending you your 10-digit Unique Taxpayer Reference. After which, you will need to file a tax return every year. For a sole trader, business income tax is paid based on the business’s profit, which is included in your self-assessment tax return. Sole traders can also hire employees if they intend, and accordingly, they must collect employees’ Income Tax and National Insurance Contributions, which must be paid later to the HMRC.

Tax obligations for sole traders: There is a tax-free allowance for up to £12,500 income, i.e., for income lesser than this, you need not pay income tax. As part of your tax obligation, you need to keep records of your business’s sales and expenses and send a self-assessment tax return every year and pay National Insurance (NI). Additionally, you will need to register for VAT if your earning exceeds or expects to exceed £85,000 over 12 months. Sole traders do not need to pay corporation tax.

2. Partnerships
A business between which is operated by two or more persons in common is a partnership structure. Partnership businesses are governed in the UK by the Partnership Act 1890. Similar to a sole trader business, the partnership is not a separate legal entity. Partners generally have unlimited liability. However, there are two more types of partnership apart from the general partnership: Limited Partnership and Limited Liability Partnerships (LLPs).

i) Limited Partnership
In limited partnerships, one of the partners must be a general partner, and one must be a limited partner. General partners are liable for all business debts and obligations, while a limited partner contributes a sum of money as capital or property valued at a stated amount. Limited partners are not liable for the debts and obligations of the firm beyond the amount contributed. A general partner is responsible for registering the business. In this structure, you need to make sure that you, your partner and your business are registered with HMRC separately for tax assessment.

ii) Limited Liability Partnerships (LLPs)
LLP are a hybrid of an ordinary partnership structure and a private limited company. It has the benefits of both forms of business entity combined. Like other partnership structure, LLPs must have at least two persons, who in this case are known as ‘members’. There have to be at least two numbers of ‘designated members’ and any number of ordinary members. Unlike a conventional partnership, an LLP is an incorporated company, and, as such, it is considered a separate legal entity. LLPs need to register with Companies House (CH) and each member registered as self-employed with HMRC.

Tax obligations for partnerships: Ordinary partnerships have similar tax obligations as a sole trader, i.e., partners must pay income tax and National Insurance. All members have to send a personal self-assessment tax return and register for VAT if earnings exceed or expected to exceed £85,000. Also, the nominated partner is required to send a partnership self-assessment tax return on an annual basis.

In the case of limited partnership and limited liability partnership, each partner is obligated to pay income tax on their share of the business’s profits. They have to send a personal self-assessment tax return, pay National Insurance and register for VAT if earnings exceed or are expected to exceed £85,000 like an ordinary partnership. However, you must send a partnership self-assessment tax return on an annual basis.

3. Company
There are various types of companies that are functional in the UK. Today let us discuss the three major types of companies –
1) Private Limited Companies (Ltd)
In this business structure, the liability of members or subscribers of the company is limited to what they have invested or guaranteed to the company. This can be of two types –
a. Private company limited by shares- The liability is limited to the amount, if any, unpaid on the shares held by them. The shares cannot be traded publicly.
b. Private company limited by guarantee- The liability is limited to the amount that the members guarantee to contribute to the company’s liquidation.

2) Public Limited Company (PLC)
In this business structure, the company’s shares may be traded publicly on a stock exchange. An authorized minimum share capital of £50,000 is required for this structure.
3) Unlimited company
An unlimited company is very much similar to a standard private company limited by shares; however, there is no protection for members and shareholders in case of business failure.

You can register your company with Companies House under the provisions of the Companies Act 2006 by providing the required set of information.

Tax obligations for companies: In the case of limited companies, the company need to send Companies House an annual tax return, compile statutory accounts, send a company tax return to HMRC, and register for VAT if it exceeds the threshold. Additionally, a limited company director is required to return a self-assessment tax return and pay tax and National Insurance through PAYE if they receive a salary from the business. Unlimited company whereas generally does not require filing annual accounts at Companies House. However, the directors need to make sure that the company’s financial statements are prepared at a timely interval.

TAX AND PAYE

We just stated that the business pays tax and National Insurance through PAYE, so what is PAYE? PAYE means Pay As You Earn. It is a way through which the HMRC collects tax from employees and employers. With the help of PAYE, you can deduct the income tax and National Insurance contribution of your employee and pay to HMRC later. How much money your employee lose or you lose as a self-employed individual is dependent on the tax code. You must keep a check on this tax code and get it fixed as and when required.

1. Income Tax
UK levies most tax at progressive rates, and the same is valid for income tax. This means the higher the income, the higher will be the tax rate. Tax is levied on all income you receive personally, such as salary and dividends minus deduction and allowance. Speaking of allowance, individuals are entitled to a personal allowance on which they don’t have to pay any tax. For the financial year 2020/21, the allowance is £12,500, and for income over £125,000, there is no personal tax allowance. You can file your self-assessment return online or by post. Also, in case of any changes, you must notify HMRC in advance.

Given below is the British tax rate for 2020/21:

England/Wales/Northern Ireland tax band Taxable income Income tax rate
Personal allowance Up to £12,500 0%
Basic rate £12,500–£50,000 20%
Higher rate £50,001–£150,000 40%
Additional rate £150,001+ 45%

Scotland tax band Taxable income Income tax rate
Personal allowance Up to £12,500 0%
Starter rate £12,501–£14,585 19%
Basic rate £14,586–£25,158 20%
Intermediate rate £25,159–£43,430 21%
Higher rate £43,431–£150,000 41%
Top rate £150,000+ 46%

2. National Insurance Contributions (NIC)
National Insurance Contributions (NIC), also known as National Insurance, form a substantial proportion of the UK Government’s revenue. There is no ceiling to National Insurance Contributions, and these are not deductible from compensation for income tax purposes. National Insurance Contributions are payable by employees, employers and the self-employed alike. However, the mandatory percentage of contribution is different for each entity.

3. Corporation Tax
Corporation tax is paid once your company begins to make a profit. Currently, as of 2020/21, it is 19% on net earnings. A lower rate of 10% is applied when the profits arising from the exploitation of patents, while specific corporation taxes apply in certain cases. Member and shareholders receive their dividends after the payment of corporation tax.

4. Value Added Tax (VAT)
A business with a turnover of over £85,000 must register for VAT. VAT is a consumption tax added to the cost of goods and services; it is charged at 20%. You can register voluntarily for VAT if it suits your business or expects your business to cross the threshold. Generally, businesses opt voluntarily in circumstances where they want to sell to other VAT-registered businesses and want to reclaim the VAT. VAT applies to self-employed, partnerships and limited companies. Not all goods and services attract VAT, and a few goods and services attract a lower rate of 5%.

5. Capital Gains Tax
Capital gains tax is applicable to gain from the disposal of a capital asset. You pay CGT on the gain you receive from these assets, not on the entire sale price. In case of loss, the capital losses can be brought forward to next year. In the case of basic rate taxpayer, the rate payable depends on the size of the gain, taxable income and whether the gain is from residential property or other assets.

6. Business Rates
Business rates are a property tax, and it applies to the non-domestic property. It forms a part of the funding for local government. The local government collects it; however, the tax amount is pooled centrally and then redistributed.

7. Environmental taxes
Environmental taxes are taxes that encourage businesses to operate in a more environmentally friendly way. There are taxes and schemes for different types and size of business. Few environmental taxes which might apply to your business are –
a) Climate Change Levy (CCL)
b) CRC Energy Efficiency Scheme
c) Emissions trading
d) Capital allowances on energy-efficient items
e) Landfill Tax
f) Aggregates Levy

8. Customs duty
Customs duty is levied on goods posted or couriered to you from another country. For goods worth less than £135, you will not have to pay anything to the delivery company to receive goods unless they’re gifts over £39 or excise goods (for example, alcohol and tobacco). It is applicable irrespective of whether the good is new or old that you –
• buy online
• buy abroad and send back to the UK
• receive as a gift

9. Excise duties
In the case of a few goods, excise duty will be chargeable in addition to any Customs Duty which may be due. These goods are –

• wine and made-wine
• beer
• cider and perry
• spirits
• low alcohol beverages
• imported composite goods containing alcohol
• tobacco products
• hydrocarbon oil – this section includes details about rebates for such products
• Climate Change Levy
• Biofuels
These goods may be of UK origin, received in the UK following an intra EU movement, or imported from outside the UK or EU.

Conclusion

While all this information can be overwhelming, you need to continuously keep updated with any changes or updates in the current taxation system. If not, at least you must have either a full-time accountant or online accountant who can help you stay compliant with all laws and regulations while making the best use of any benefit offered by the government. Also, note that few industries attract different taxes; for example, Construction Industry Scheme (CIS) is applicable in the real estate industry, where a contractor must deduct money from a subcontractor’s payments and pass it to HM Revenue and Customs (HMRC). If you are starting a business in the UK or need accounting & bookkeeping services to comply with the UK taxation system. In that case, you can contact our experts and have 30 mins free consultancy.