Taxes 101 – How to become tax efficient
For small businesses, high earning individuals or sole traders and freelancers, becoming tax efficient is an important factor in maximising your earnings.
There are a bevy of strategies, reliefs and mechanisms in place for you to minimise your tax burden, while still paying your fair share.
In this article, we’ll answer the burning questions around tax, and share some advice on the following areas:
- What is tax efficiency? A definition
- General tax efficiency tips
- Tax efficiency tips for small businesses
- How to make use of tax reliefs
Simply put, tax efficiency is when a business or individual pays the least amount of taxes required by law. A financial process is said to be tax efficient when it results in less tax being paid than an alternative financial instrument that achieves the same end.
It’s important to note: this is legal. It isn’t tax evasion. It’s about using the mechanisms in place to reduce the tax burdens of legally conducted business.
There are good practice tips that anyone can make in regards to reducing their tax bill. While it is most likely applicable to the self-employed, or anyone required to file a self assessment tax return, some of these tips are applicable to those on pay as you earn.
- Pay in a pension scheme: Contributions you make to your employer’s pension scheme can also be made from your gross pay, before tax is charged. The government would top up your pension with tax relief, which will give you a bonus for saving till retirement. Self employed people also receive at least 25% tax relief on any contributions made into a personal pot, with additional rates of a further 20% if you’re paying the top rate of tax.
- Check your tax code: Your tax code indicates how much tax HMRC will collect from your salary. This can be found on your payslip. Check your tax code each year to make sure it’s correct for your situation. If you’re on the wrong code, you may be entitled to pay less tax in coming months, or receive a rebate for the previous years.
- Reclaim overpaid taxes : If you are a non-taxpayer, or your income unexpectedly falls during a year, you might find that you have been taxed more than you should have,since HMRC assumes that you are using your personal allowance equally for every month. To reclaim it, you need to fill out form R40 from HMRC, or simply give them a call. In case you are filing a self assessment tax return, any refund owed by HMRC won’t be processed until it receives the money. So planning ahead and filing well before the January deadline means you may receive a rebate quicker. So the sooner you file, the better it is for you and your business.
It is crucial for small businesses to maintain a high level of efficiency. Paying too much in tax can have a profound effect on cash flow, limiting your ability to make payments necessary for running your business, or investing in growth.
Conversely, paying too little has its own pitfalls. Let’s say you’ve frontloaded some tax deductible expenses into the ongoing financial year. The next year, having planned for a similar bill from HMRC, you overspend, leaving you pinching pennies to square up the difference with the revenue services. Being tax efficient will mitigate these boom and bust periods.
- Appraise your current position before the end of the financial year: Before the end of year rush, take a look at your income and expenditure, and consider how you can mitigate your tax burden. Maybe you could defer income until the next financial year — only do this if the business’s cash flow is healthy — consider making deductible purchases on equipment or supplies, or even make a donation to charity. All of these methods can reduce your tax bill if it’s getting a bit bloated.
- Minimising tax liability: Start a retirement plan, adopt a different business structure and defer income to increase your reductions. Many other small businesses also minimise liability by adding to their employee benefits fund as well as by giving raises or bonuses in the existing year.
- Employ your family member: Hiring your spouse or child allows the business to take advantage of lower tax rates. The minimum wage does not apply to people working for a business owned by someone in the same household, offering a real savings opportunity on PAYE contributions. However, it’s important to provide proof that the family member is being paid as an employee, with the money being sent to a privately held bank account.
Tax reliefs are breaks given to businesses to encourage activity in certain industries, or simply make your company’s life a little bit easier. Here are some examples:
- Research and development: The UK Government allows your business to claim tax credits for work related to Research and Development (R&D). The main purpose is to reward business ideas that promote some kind of innovation. This is chronically underused: there are almost £84 billion of unclaimed tax reliefs that is owed to SMEs.
- Employment allowance: This applies to businesses paying the Class 1 National insurance. It allows eligible employers to reduce their annual National Insurance liability by up to £5,000
- Business rates: There is also a tax relief for your business in case you own a property having a value of up to £15,000. In many cases, you can even reduce your business rates bill to zero.
- Patent tax relief: Innovative businesses can claim 10% tax relief on profits generated by patented inventions.
The quickest route to tax efficiency? Get in touch with a qualified accountant. They know all the tips and tricks in minimising your tax burden, while keeping you compliant.