Starting a business is an exciting venture, filled with opportunities to innovate and grow. However, the financial aspects, especially tax planning, can often feel daunting. From choosing the right business structure to making the most of available tax reliefs, getting a handle on your tax obligations early is vital.
In this guide, we’ll explore some key tax considerations for startups, helping you plan efficiently from day one while setting your business up for success as it scales.
Understanding your business structure
One of the first decisions any new business owner must make is selecting the right structure. This choice has a significant impact on your tax obligations. Common structures for UK businesses include sole traders, partnerships, limited liability partnerships (LLPs) and limited companies (LTDs).
Many startups opt for the limited company model. It offers benefits such as reduced personal liability and the ability to retain profits within the business, which can be taxed at the lower corporation tax rate of 19% (as of 2024). However, the additional reporting requirements and costs of running a limited company can be a consideration for smaller businesses.
On the other hand, sole traders may find the simplicity of their structure attractive. But remember that personal assets are not protected, and you’ll pay income tax on all profits, which could rise to as much as 45% for higher earners. As your business grows, it’s worth revisiting your structure to ensure you’re still operating in the most tax-efficient way.
Taking advantage of research and development tax credits
The research and development (R&D) tax relief scheme is a valuable incentive for businesses engaged in innovation. If your startup is investing in developing new products, processes or services, you may be able to claim back a portion of your expenditure on eligible R&D costs through tax credits.
HMRC statistics show that in 2022 alone, over £7.7bn in R&D tax credits were claimed by UK businesses. This can be a significant cash injection for early-stage businesses developing their market offerings. Keep accurate records of your R&D activities to maximise this relief, as HMRC requires detailed documentation to support claims.
Managing losses and carry-forward relief
Many startups experience losses in their early years, especially as they invest heavily in product development, marketing and building a customer base. While this might feel like a setback, tax relief can turn these losses into an advantage.
Tax law allows businesses to carry forward losses and set them against future profits. This means that you can reduce your tax bill once your business generates income by offsetting previous losses. Keeping thorough financial records is key to ensuring you can claim this relief effectively when the time comes.
Capital investments and tax relief
Initial capital investments, such as purchasing equipment, machinery or technology, are essential for many startups. Fortunately, these expenditures can qualify for capital allowances, which can help reduce your tax liability.
The annual investment allowance (AIA) permits businesses to deduct 100% of the cost of qualifying assets from their profits up to a limit of £1m per year. This can substantially affect your taxable income, allowing you to reinvest those savings into the business.
Not all assets qualify for AIA, so make sure you’re clear on what’s eligible and how to properly document these investments.
Staying compliant with VAT
Value-added tax (VAT) registration becomes mandatory once your business’s taxable turnover exceeds £90,000 in a 12-month period. However, even if you’re below this threshold, voluntary VAT registration might be beneficial, especially if you plan to deal with other VAT-registered businesses. Being VAT-registered can boost your credibility and allow you to reclaim VAT on business expenses.
The VAT system comes with additional administrative burdens, including filing quarterly VAT returns. Consider whether the benefits outweigh registration costs, particularly in the early stages of your business.
Planning for the future: Tax-efficient growth
As your business grows, you must ensure your tax strategy adapts accordingly. For example, many startups eventually bring on investors, which can introduce new tax considerations. Planning for tax efficiency during growth phases might involve restructuring the business or taking advantage of tax reliefs for investment, such as the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS), which provide tax incentives to investors in qualifying businesses.
Regularly reviewing your tax position and seeking professional advice can help you avoid costly mistakes and ensure your business remains on a sound financial footing as it scales.
Talk to us
Tax planning is an essential part of running a startup, and getting it right can make a significant difference in your business’s long-term success. Whether choosing the right business structure, taking advantage of tax reliefs like R&D credits or managing losses, a proactive approach to tax can help you make the most of your finances.
At Pearson May, we specialise in supporting startups through the critical early years. With our expertise in tax planning, we can help you build a solid foundation and ensure your business grows tax-efficiently.
Reach out to us today for tailored advice and guidance.