Bookkeeping & Accounting All-in-One For Dummies (2015)

Book V

Accountants: Managing the Business

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In this book …

·        See how an accountant can help to structure your business.

·        Explore the types of accounting methods that an accountant can help you use within your accounting system.

·        Look at different methods of profit performance.

·        Consider costing and budgeting within your business.

·        Perform ratio analysis.

Chapter 1

Discovering Different Business Types

In This Chapter

arrow Sorting out business legal structures

arrow Reporting on self-employment and partnership tax

arrow Filing taxes for limited companies

Before you begin your business, cast your mind forward and determine what you think your business is going to look like over the next few years. For example, do you see yourself heading up a multinational corporation with lots of people working for you? Or, do you perhaps see yourself on your own, working the hours that suit you, picking the jobs that you want to do? Make sure that you take a few minutes to consider this, because your answers to these questions have an impact on which structure is most suitable for your business.

Whichever structure that you decide to start with determines how much administration needs to be done and who you need to inform that you’ve started a business. For example, paying taxes and reporting income for your business are very important jobs, and the way in which you complete these tasks depends on your business’s legal structure. From sole traders (self-employment) to limited companies and everything in between, this chapter briefly reviews business types and explains how taxes are handled for each type.

Finding the Right Business Type

Business type and tax preparation and reporting go hand in hand. If you work as a bookkeeper/accountant for a small business, you need to know the business’s legal structure before you can proceed with reporting and paying tax on the business income. Not all businesses have the same legal structure, so they don’t all pay tax on the profits they make in the same way.

But before you get into the subject of tax procedures, you need to understand the various business structures that you may encounter. This section outlines each type of business. You can find out how these structures pay taxes in the separate sections that follow.

Sole trader

The simplest legal structure for a business is the sole trader, a business owned by one individual. Most new businesses with only one owner start out as sole traders, and some never change this status. Others, however, grow by adding partners and become partnerships. Some businesses add lots of staff and want to protect themselves from lawsuits, so they become Limited Liability Partnerships (LLPs). Those seeking the greatest protection from individual lawsuits, whether they have employees or are simply single-owner companies without employees, become limited companies. We cover these other structures later in this chapter.

Partnership

HM Revenue & Customs considers any unincorporated business owned by more than one person to be a partnership. The partnership is the most flexible type of business structure involving more than one owner. Each partner in the business is equally liable for the activities of the business. This structure is slightly more complicated than a sole trader (see the preceding ‘Sole trader’ section), and partners need to work out certain key issues before the business opens its doors. These issues include:

·        How are the partners going to divide the profits?

·        How does each partner sell his share of the business, if he so chooses?

·        What happens to each partner’s share if a partner becomes sick or dies?

·        How is the partnership going to be dissolved if one of the partners wants out?

remember Partners in a partnership don’t always have to share equal risks. A partnership may have two different types of partners: general and limited. The general partner runs the day-to-day business and is held personally responsible for all activities of the business, no matter how much he’s personally invested. Limited partners, on the other hand, are passive owners of the business and not involved in day-to-day operations. If someone files a claim against the business, the limited partners can be held personally liable only for the amount of money he individually invested in the business.

Limited Liability Partnerships (LLPs)

The Limited Liability Partnership, or LLP, is a structure that provides the owners of partnerships with some protection from being held personally liable for their business activities. This business structure is somewhere between a partnership and a limited company: the business ownership and tax rules are similar to those of a partnership, but like a limited company, if the business is sued, the owners aren’t held personally liable.

Rather like forming a limited company, an LLP is formed by filing the appropriate forms with Companies House. On receipt of these forms, the Registrar of Companies issues a Certificate of Incorporation.

tip Both for business and practical reasons, we recommend drawing up an agreement to establish the rights, responsibilities and duties of the partners to each other, and to outline how they’re going to run the business, because few provisions are contained within the act governing these relationships.

Growth of the LLP

Limited Liability Partnerships are the latest business vehicle and were introduced on 6 April 2001 after the Limited Liability Partnerships Act 2000 received royal assent on 20 July 2000. Many law firms and accounting firms are set up as LLPs. More and more small-business owners are choosing this structure rather than a limited company because the LLP is easier and cheaper to maintain (it involves a lot less paperwork, plus fewer legal and accounting fees), and yet still provides personal protection from legal entanglements.

Limited companies

If your business faces a great risk of being sued, the safest business structure for you is the limited company. Courts in the UK have clearly determined that a limited company is a separate legal entity (Saloman v. Saloman 1897) and that its owners’ personal assets are protected from claims against the company. Essentially, an owner or shareholder in a company can’t be sued or face collections because of actions taken by the company. This veil of protection is the reason that many small-business owners choose to incorporate even though it involves a lot of expense (to pay for both lawyers and accountants) and paperwork.

In a limited company, each share represents a portion of ownership, and profits must be split based on share ownership. You don’t have to sell shares on the public stock markets in order to be a limited company, though. In fact, most limited companies are private entities that sell their shares privately among friends and investors.

If you’re a small-business owner who wants to incorporate, first you must form a board of directors (see the sidebar ‘Roles and responsibilities of the limited company board’). Boards can be made up of owners of the company as well as non-owners. You can even have your spouse and children on the board – bet those board meetings are interesting.

Roles and responsibilities of the limited company board

Limited companies provide a veil of protection for company owners, but in order to maintain that protection, the owners must comply with many rules unique to corporations. The board of directors takes on the key role of complying with these rules, and it must maintain a record of meeting minutes that prove the board is following key operating procedures, such as:

·        Establishment of records of banking associations and any changes to those arrangements

·        Tracking of loans from shareholders or third parties

·        Selling or redeeming shares

·        Payment of dividends

·        Authorisation of salaries or bonuses for officers and key executives

·        Undertaking of any purchases, sales or leases of corporate assets

·        Buying another company

·        Merging with another company

·        Making changes to the Articles of Incorporation

·        Election of corporate officers and directors

Corporate board minutes are considered official and must be available for review by HM Revenue & Customs and the courts. If a company’s owners want to invoke the veil of protection that corporate status provides, they must prove that the board has met its obligations and that the company operated as a limited company. In other words, you can’t form a board and have no proof that it ever met and managed these key functions.

Tax Reporting for Sole Traders

HM Revenue & Customs doesn’t consider sole traders and partnerships to be individual legal entities, so they’re not taxed as such. Instead, sole proprietors report any business earnings on their annual tax returns – that’s the only financial reporting they must do. In effect, sole traders and partnerships pay income tax on their business profits. To be technical, they pay their income tax on their business profit under what is called trading income. A sole trader may well have another job as well, on which he pays tax under the normal Pay As You Earn (PAYE) system. All these sources (and other sources of income) are pulled together on the tax return to assess the overall income tax liability.

The basic tax return covers everything that a person in paid employment needs to tell HM Revenue & Customs to get his tax assessed correctly. The numerous pages of questions cover every aspect of tax related to normal tax life – working, receiving dividends, earning interest, paying and receiving pensions, making small capital gains – as we said, everything.

As the bookkeeper/accountant for a sole trader, you’re probably responsible for pulling together the sales, cost of goods sold and expense information needed for the forms. In most cases, you send off this information to the business’s accountant to fill out all the required forms.

Ultimately, because sole traders pay income tax on all their earnings, you need to note the current rates of tax for sole traders (and other unincorporated bodies) based on their taxable profits. Table 1-1 gives this information.

Table 1-1 2014/15 Taxable Profits

Tax Rate

2014/15 Taxable Profits

Basic rate: 20%

£0–£31,865

Higher rate: 40%

£31,866–£150,000

Additional rate: 45% from 6 April 2013

Over £150,000

Fortunately, most people have simple tax affairs. Because employment is usually taxed under the PAYE system (the employer acts as the unpaid tax collector) and most other sources of income have basic rate of tax deducted at source, you don’t need to complete a tax return each year. The tax return is needed to pull all the earnings together only where an individual may have a liability to higher rate tax, for example – other earnings that have not had tax deducted at source that push their taxable earnings above the basic tax rate.

Expanding to the supplementary pages

To deal with liability at a higher tax rate or areas too complex for the standard annual tax return, you need supplementary pages. The supplementary pages cover:

·        Employment: To cover more complicated employment situations; for example, an employee who has more than one job.

·        Share schemes: To cover an employee who receives shares under an employee share ownership scheme.

·        Self-employment: These pages cover business profits for the sole trader. We look at this subject more closely in the next section.

·        Partnerships: To declare your share of any partnership profits.

·        Land and property: For example, where any rental income is received from any property.

·        Foreign: To cover any overseas sources of income.

·        Trusts: To cover any income received by means of a distribution from any trust set up for you.

·        Capital gains: To cover any gains made from the disposal of assets rather than trading income.

·        Non-residence: To cover any income received by non-residents in the UK and thus liable to UK tax.

remember HM Revenue & Customs sends supplementary pages only if you ask for them or have received them before. As a taxpayer, you’re responsible for asking for a tax return and completing one every year.

Filling out the self-employment supplementary pages

This section concentrates on the supplementary pages that relate to running a business. Depending on your turnover, you use one of two different self-employment supplementary pages. If your turnover is less than £79,000, you can complete the shortened version, which is only two pages long. Double-check that you’re eligible to use the shortened form by referring to the guide to completing the self-employment supplementary pages. You can find it on the HMRC website, www.hmrc.gov.uk . Search for form SA103S.

On the first page, SES1, you put down details of the business name and address and when it began or ceased trading. You also use this page to enter your business income and allowable business expenses. (Refer to Book IV, Chapter 1 for a refresher.) You put your total business expenses in box 20 if your turnover is less than £79,000. On the second page, SES 2, you summarise the capital allowances that the business is claiming for any of its assets. You then calculate your taxable profits and read page SESN9 of the notes to see whether you need to make any adjustments.

Losses, Class 4 National Insurance Contributions and Construction Industry Scheme (CIS) deductions are entered in the final section. (Make sure that you read page SESN10 of the notes to help you complete this section correctly.)

Filing Tax Forms for Partnerships

If your business is structured as a partnership (meaning that it has more than one owner) and isn’t a limited liability company, your business doesn’t pay taxes. Instead, all money earned by the business is split up among the partners and they pay the tax due between them very much as if they were sole traders. However, a partnership is required to complete a partnership tax return to aid the assessment of the members of the partnership. Essentially, the partnership tax return is sent out to the nominated partner and he completes the partnership tax return in a manner similar to the sole trader tax return explained in the preceding sections. That partner states what profit share is attributable to each partner, and each partner is responsible for showing this profit figure in his own personal tax return.

warning Don’t be tempted to forget to include partnership profits (or any other source of income for that matter), because HM Revenue & Customs knows from the partnership tax return what you earned in that tax year.

Paying Taxes for Limited Companies

Limited companies are more complex than sole traders and partnerships. Although many aspects of their accounting and taxation are similar, their accounts are open to public scrutiny because each year a limited company must file its accounts at Companies House, the UK government organisation responsible for tracking information about all UK limited companies. This requirement means that although only HM Revenue & Customs knows the full details of a sole trader or partnership, the whole world has access (for a fee) to a limited company’s accounts.

Companies make a separate tax return, known as a CT600, to HM Revenue & Customs, in which they detail their financial affairs. As a result, the limited company pays corporation tax on its earnings (profit) as well as tax on any dividends paid out to its shareholders. This arrangement means that its shareholders receive dividends net of basic rate of income tax because the company has already paid it for them. Two forms of CT600 exist: a short version, only four pages, is sufficient for companies with straightforward tax affairs, but more complicated companies, as designated by HM Revenue & Customs, must complete the eight-page return. Check with your accountant whether you need to complete the eight-page return.

From April 2011, companies must file their corporation tax online for accounting periods ending after 31 March 2010, and pay electronically too. The HMRC website provides a lot of help and advice, so don’t panic – just click on Corporation Tax on the Businesses and Corporations menu from the home page.

Corporation tax rates vary according to how much taxable profit the company makes. Although starting rates are low for a limited company, they soon escalate to the higher (main) rate. Current corporation tax rates on profits are shown in Table 1-2.

Table 1-2 Corporation Tax Rates

Rates for financial years starting on 1 April

   

Tax Rate

2013 Taxable Profits

2014 Taxable Profits

Small profits rate:

20%

20%

Small profits rate can be claimed by qualifying companies with profits not exceeding:

£300,000

£300,000

Marginal relief: lower limit

£300, 000

£300,000

Marginal relief: upper limit

£1,500,000

£1,500,000

Main rate:

23%

21%

warning Check with your accountant to determine whether incorporating your business makes sense for you. A strong argument exists in favour of some smaller businesses incorporating, because they pay less corporation tax than income tax at certain levels. But tax savings isn’t the only issue you have to think about; operating a limited company also increases administrative, legal and accounting costs. Make sure that you understand all the costs before incorporating.

Have a Go

Try these questions to work out which type of business structure is suited to each occasion:

1.     You decide to start your own home-based business, but want protection from being held personally liable for your business’s activity. Which type of business structure would you be likely to pick?

2.     You and two of your friends decide to start a band and you need to pick a business structure. Which type of business structure would you pick if you want to keep things as simple as possible?

3.     You decide to start your own home-based business. Which type of business structure would be easiest for you to use in order to get started?

Answering the Have a Go Questions

1.     You’d be likely to choose a limited company. You can be sued personally if you structure your business as a sole proprietorship, but you’ve additional protection with a limited company; your personal assets are protected.

2.     The simplest structure is likely to be a partnership. However, you’d need to agree how to share profits and what would happen if a member decided to leave the band. You should set up a simple partnership agreement to avoid complications in the future.

3.     Choosing to be a sole trader is the easiest way to start up in business. You can start trading immediately, using your own name or a trading name.