Have you ever wondered how taxation can impact a business? What kind of taxes is a company supposed to pay? How are taxes calculated? How do changes in taxes affect a business?
Let's take a look!
- We're going to give you an introduction to taxation.
- We'll focus on its impact on businesses.
What is taxation on business?
A tax is a payment made by individuals and businesses to the government. It is used for funding public spending on education, infrastructure, healthcare, defence, etc.
The amount of tax is calculated as a percentage of income or spending. In the UK, there are five main types of taxes:
Income tax
National insurance
Value-added tax (VAT)
Corporate tax
Business rates.
Types of business tax
Most taxes are classified as direct or indirect taxes.
Tax on Business: Direct tax
This is taxation on income. It is deducted from an employee’s salary or a business’s earnings and paid directly to the government. In the UK, direct taxes are progressive, meaning the higher your income, the more taxes you have to pay. Some examples include income tax, national insurance, and corporation tax.
Tax on Business: Indirect tax
This is taxation on spending. Businesses collect indirect taxes on the government's behalf by adding them to the price of their products and services. Indirect taxes are regressive, meaning they are not based on your income. No matter how much you earn, you pay the same amount of tax for the goods. A common indirect tax is value-added tax (VAT).
Direct and indirect tax can be split further into income tax, national insurance, VAT, corporate tax, and business rates. Let's have a closer look at each of these!
Types of Taxes, StudySmarter
Tax on Business: Income tax
The payment of income tax is compulsory for all individuals. However, there's often a personal allowance, under which you are exempt from tax. In the UK, the income tax personal allowance is £12,570 per year. You don't have to pay taxes for the first £12,570 you make each year.
Income tax is a tax on a person’s income.
Income tax is progressive, so the more you earn, the higher income taxes you have to pay.
Here are the tax rates for different income brackets in the UK.
| Taxable income | Tax rate |
Personal allowance | Up to £12,570 | 0% |
Basic rate | £12,571 to £50,270 | 20% |
Higher rate | £50,271 to £150,000 | 40% |
Additional rate | Over £150,000 | 45% |
Income tax rates in the UK, gov.uk
Suppose you earn £50,000 per year, how much income tax do you have to pay to the government?
Personal allowance = £12,570
Taxable income = £50,000 - £12,570 = £37,430
Income tax = 20 percent
20 percent x 37,430 = 7,486
You need to pay a total of £7,486 in income tax per year.
Tax on Business: National insurance
National insurance is the money contributed to the National Health Service (NHS), unemployment benefits, illness and disability allowances, and state pension.
In the UK, any person aged above 16 who earns a salary of £155 or more per week, or is self-employed with a profit of £5,955 or higher per year, is obliged to pay national insurance. Those not paying won't be able to receive benefits such as unemployment or state pension.
There is a national insurance number issued to each citizen. The contribution amount depends on how much you earn, but the payment is often split between you and the employer. Both income tax and national insurance are automatically deducted from your salary and added to the national tax revenues. The amount paid is shown on payslips.
Tax on Business: VAT
VAT, or Value-Added Tax, is a tax on a good or service purchased.
Most products and services are charged with VAT. The standard VAT rate in the UK is 20 percent. However, there are also reduced rates or zero rates for special goods or services.
| VAT | |
Standard rate | 20 percent | Most goods and services |
Reduced rate | 5 percent | Some goods and services such as home energy or children’s car seats |
Zero rate | 0 percent | Zero-rated goods and services such as most food and children’s clothes |
VAT rates in the UK, gov.uk
Other VAT-exempt products and services include physical education, sports activities, lottery tickets, museum entrance, charity fundraising events, medical treatment, etc.
Tax on Business: Corporation tax
Corporate tax is a tax paid by a business to the government.
In the UK, limited and unlimited businesses are taxed differently.
A limited company is taxed as a separate entity from the owner, whereas an unlimited company (sole traders, partnerships) are taxed as one single entity.
For limited companies, the corporation tax is calculated on the annual profits. Sole traders and partners pay tax through a self-assessment system each year. Their income taxes and national contributions are calculated on business profits after expenses.
The standard corporate tax rate in the UK is 19 percent.
Tax on Business: Business rates
Business rates are levied based on the property on which the business operates.
There are different types of property where business rates apply such as pubs, offices, shops, factories, warehouses, guest houses, non-domestic buildings, or parts of a building.
The importance of taxes on business
Businesses pay many types of taxes, including income tax, national insurance (shared with employees), and business rates. Taxes are calculated on the profit of a company. Thus, having an efficient tax policy can help a business to reduce tax liability and increase profitability.
Any change in taxes will have a significant impact on business. For example, an increase in income tax will reduce the consumer’s disposable income (income after income tax). This means people will have less money to spend on goods and services, resulting in lower demand and sales revenues for the business. With less revenue, the business might not be able to invest in new machinery or different financial projects for growth and expansion. If demands continue to drop, the company may not have enough money to cover daily operations and go out of business.
Effects of changes in tax on business
The government can increase taxes to raise more money for public spending, or reduce taxes to encourage more spending in the economy. In both cases, there will be huge implications on the level of consumer spending and business functions.
If the government reduces income tax, consumers' disposable income will rise, leading to more spending. Conversely, an increase in VAT will increase the price of goods and discourage spending.
In most cases, businesses will try to pass the tax increases to the consumer. However, this can change based on the level of competition in the market.
Businesses are most affected when there is a rise in corporate taxes or business rates. An increase in national insurance will also incur more costs for companies as the payment is shared between employees and employers.
Taxes are an integral part of government income, raised from individuals and businesses. The government can change tax policies every year. As taxes rise or fall, business incomes and expenses will also be affected.
Tax on Business - Key takeaways
Tax is a percentage of income or spending paid by individuals and businesses to the government.
There are two types of taxes: indirect and direct.
Indirect taxes are collected by businesses on behalf of the government, e.g. VAT.
Direct taxes are paid directly by individuals and businesses to the government, e.g. income tax.
Five common types of taxes in the UK include:
Income tax. It is progressive, i.e., it is based on a person’s income.
VAT is a tax on goods and services purchased. It is regressive, i.e., it is not based on a person’s income.
National insurance is used for state pensions and other social causes. It is split between employees and employers.
Corporate tax is paid by businesses to the government. Limited and unlimited businesses are taxed differently.
Business rates are taxed based on the property where a business takes place.
Changes in taxes can affect the level of consumer spending and so, businesses themselves.
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