A Franchise Owner's Guide to Taxes

17/04/2019 09:30 | Start a business

Franchise tax guide

Originally uploaded on 11/10/2017. Updated on 17/04/2019.

Franchising can take away some of the stresses that come with starting up a business. Entrepreneurs that invest in a new unit of an established business can benefit from a proven business model and tailored support from the franchisor, but they still have to pay the same taxes a standard business owner would.

Sole Trader vs Limited Company

There are several legal structures under which franchises can operate, the most common of which are sole trader and limited company. Depending on the business status, its tax requirements will be different.

A sole trader is officially classed as self-employed and is the only owner of their business. They can keep the business profits after taxes have been paid, but if the business accumulates debts, their personal assets, such as their house, can be taken away.

Limited companies, on the other hand, have their own legal identity, separate from their founders who become directors and shareholders. Unlike sole traders, those involved in a limited company can only lose the assets that have become part of the business. However, limited companies must pay corporation tax.

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So, what are the main taxes that the owner of a franchise unit should be aware of?

Income Tax

All business owners must pay income tax, which is tax on any profits made. Just as employees pay tax on their salary, business owners must pay tax on their business profits. However, you only pay income tax on profits over £12,500, so if you earn less than this, you do not pay any tax. If you made £20,000, for example, you would only pay tax on £7,500 of your earnings. The percentage of tax you pay is dictated by the tax bracket you belong to. The brackets are dependent on income, so the more you earn or make, the more tax you have to pay.

If you run your business alongside a regular job, you may have to pay income tax on your salary sooner than you would if your income came from your regular job alone.

National Insurance

Although National Insurance (NI) is not technically a tax, its often treated like one because it is paid to the government. If you are employed within a business, your National Insurance contributions will be deducted from your wages by the employer and sent to HMRC. However, business owners must file a self-assessment form in order to pay National Insurance. It is vital that you pay your contributions correctly, but this can be confusing, as there are several different classes:

Class 1: This applies to employees below the state pension age who earn more than £166 a week.

Class 2: This applies to self-employed workers or business owners who earn more than £6,365 a year.

Class 3: This is a voluntary tax donation. If you are exempt from paying Class 1 or 2 contributions, you can make a voluntary donation to make sure that there are no gaps in your National Insurance record, as this can affect your state pension.

Class 4: This applies to self-employed workers or business owners who earn more than £8,632 a year. Unlike Class 2 contributions, which is a fixed payment, Class 4 contributions are linked to your income; the more you make, the more National Insurance you have to pay.

Corporation Tax

As previously stated, this type of tax is paid by limited companies. A business corporation tax is calculated as 19 percent of its profits. However, unlike with income tax, corporation tax does not have a personal allowance, so businesses must pay it as soon as they start to make a profit.

The government has announced plans to decrease the corporation tax rate to 17 percent at the start of the next tax year, in April 2020.

VAT

Businesses can register for Value Added Tax at any point, but it becomes a legal requirement once the turnover reaches £85,000. This means that the business can charge tax on a range of specified products. Standard-rate VAT is charged at 20 percent, but a reduced rate is applied to other products, such as childrens car seats and home energy. On the other hand, products that are considered essentials are tax-free. These products include most food items and childrens clothes.

Business Rates

This is a tax on business premises; therefore, if your company has its own premises, you will be required to pay business rates. This applies to buildings such as offices, shops, pubs and warehouses. The location and size of your business premises will affect the amount you have to pay. There are various business tax relief schemes and grants designed to help with business rates.

Some buildings arent included in the business rates tax. Farm buildings, for example, do not incur the tax, and if you work from home you probably wont have to pay it either, as you will already have paid council tax on the building.

However, there are some situations in which you would have to pay business rates tax from your home-based business. If you welcome customers into your home, adapt your home for your business or employ staff who also work from home, it is likely that you will have to pay business rates.

How to Get Help with Taxes

While your franchisor will be able to give you basic knowledge about which taxes you might be required to pay, you should ensure that you seek out an accountant before you launch your business. An accountant will be able to tell you the amount of tax you need to pay and when you need to pay it. This will decrease the likelihood of incurring heavy penalties from HMRC.

For more information, take a look at the HMRC website: www.hmrc.gov.uk.

Please note: All rates and thresholds provided apply to the tax year 2019/2020.

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