Small busi­nesses, explained

Although HMRC defines an SME as a business with under 500 employees, the British gov­ern­ment have not yet published a concrete defin­i­tion of the term. Depending on what de­part­ment you are dealing with, the defin­i­tion of an SME can change con­sid­er­ably. Dif­fer­ences usually fall either in the number of employees in the business or the revenue earned.

In this article we will explain the dif­fer­ence between a small business and a medium or large sized business, as well as the ad­vant­ages and dis­ad­vant­ages of a small business.

As pre­vi­ously mentioned, an SME can be iden­ti­fied either by the amount of employees or its annual revenue. When running a small business, it is important to remember that there are different rules to follow, whether it comes to ac­count­ing or the law. A small business is

• A turnover of under £100m
• Located and run in the UK
• In­de­pend­ently owned and operated
• Not more than 500 headcount

When starting an SME, you also need to decide whether you are a small business owner or self-employed – after all, it can affect what your profits are. If you are self-employed, you can either be a sole trader, part of a part­ner­ship, or an in­de­pend­ent con­tract­or. As a sole trader, you are es­sen­tially a one-man business, re­spons­ible for all elements of the business and finances without a legal entity. Being in a part­ner­ship is very similar – it es­sen­tially involves two or more in­di­vidu­als who own the business and act as sole pro­pri­et­ors without a legal entity. Con­tract­ors are freelance workers who undertake contract work for other busi­nesses. In all three cat­egor­ies, you are not con­sidered to be an employee (unless you are a con­tract­or who is employed by an agency). Instead, the business begins and ends with you (and your partners).

If you run a small business, then you have employees. Having employees means taking re­spons­ib­il­ity for their taxes and salary, and requires a whole new area of ac­count­ing knowledge. One of the most common business types for a small business is a limited company. These are companies that bring together the concept of a cor­por­a­tion with a part­ner­ship or sole pro­pri­et­or­ship. Limited company owners are not re­spons­ible for company debts or li­ab­il­it­ies.

HMRC clas­si­fies an SME as a business with fewer than 500 employees and an annual revenue of less than £100 million when it comes to awarding a Research and De­vel­op­ment Tax Relief. The De­part­ment of Business cat­egor­ises an SME as a company with less than 250 employees when they collect stat­ist­ics. Companies House considers a small business to employ under 50 people and have an annual income of less than £6.5 million for ac­count­ing purposes. Medium sized en­ter­prises have less than 250 employees and have an annual income of under £25.9 million according to Companies House.

There are a number of legal re­quire­ments that small business owners must adhere to when setting up their small business. Once you have come up with an idea for your business and created a business plan, you will have to:

• Register your business
• Learn about and adhere to cor­por­a­tion taxes.
• Learn about and adhere to the relevant business laws and reg­u­la­tions
• Obtain any relevant business permits and licenses

Depending on the type of business you are running, you will need to register your business with HMRC, Companies House, or both, depending on what clas­si­fic­a­tion your business falls under. If you are setting up your small business as a sole trader, you can choose to trade with your own name, or choose a different name. There is no need to register if you are a sole trader, however you must be con­sist­ent when using your name and business name on any cor­res­pond­ence or documents. You may not include the following terms in your business name: ‘limited’, ‘Ltd’, ‘limited liability part­ner­ship’, ‘LLP’, ‘public limited company’ or ‘plc’. It also may not be the same name as one that is already trade­marked. The rules are the same if your SME is a part­ner­ship. Sole traders and part­ner­ships must register their business name with HMRC, but are not obliged to register with Companies House.

If your small business is a limited company, the title of your business must end in “Limited” or “Ltd” and you may not take a name that is already in use. You can use your own name or a business name. In all cases, you may not use offensive language. If your business is a Limited Company, you are required to register with Companies House, as well as HMRC. It is also advised that you register your name as a trade mark with the In­tel­lec­tu­al Prop­er­ties Office if you want to ensure ownership of the name.

The UK gov­ern­ment does not legislate for any par­tic­u­lar ac­count­ing method. As long as your accounts are clear, accurate, and can stand up to an in­spec­tion, the gov­ern­ment is satisfied. You must also ensure that your chosen ac­count­ing method will allow you to ac­cur­ately assess and pay your taxes. Cash basis and accrual ac­count­ing are ac­know­ledged as best practice for small busi­nesses. Cash ac­count­ing records income and expenses when money is exchanged, while accrual ac­count­ing records income and expenses when they are earned or billed, but perhaps not yet paid.

The kind of taxes you pay as a small business owner depends on what kind of business you are. Sole traders, part­ner­ships, and limited companies all have different tax ob­lig­a­tions. Here is an outline of which taxes are relevant to what kinds of business:

• Sole traders are required to submit a Self As­sess­ment tax return (SA100) to HMRC annually, as well as pay income tax on profits and Class 2 and 4 National Insurance (SA103S or SA103F). You will also need to register for VAT if your annual profits exceed £85,000.
   
• Part­ner­ships also submit Self As­sess­ment tax returns to HMRC on a yearly basis. Each partner in the firm is required to register and send their Self As­sess­ment returns sep­ar­ately. Part­ner­ships can be re­gistered as a whole using form SA400 and in­di­vidu­al partners may register with form SA401. Each in­di­vidu­al is also re­spons­ible for filing their own tax returns, and as is the case with sole traders, your part­ner­ship must register for VAT if profits exceed £85,000.
   
• Limited Companies must submit their accounts and a Company Tax Return to Companies House on a yearly basis. They must also pay Cor­por­a­tion Tax, as well as register for and file a Self As­sess­ment return to HMRC annually.

Small business income taxes can be filed online or in the mail to with HMRC, through their official website, or mailed to the address provided on Form 1040. Companies House returns can also be mailed to the address on the form, or completed online. Both in­sti­tu­tions prefer online sub­mis­sions, but paper is ac­cept­able provided you have a reason for being unable to file online. If your business sells goods or services and your profits exceed the VAT threshold, you will also be liable to pay VAT on your products. HMRC has a com­pre­hens­ive guide to help you assess whether you are liable, and provides in­form­a­tion on annual VAT thresholds.

There are plenty of ad­vant­ages and dis­ad­vant­ages to starting a business of any kind. Risks are always going to be taken, things might not work out – but by starting a small business, you are in control of all aspects of your career which can be an exciting (and sometimes daunting) process. Due in part to the gov­ern­ment’s lack of clarity in defining an SME, yearly stat­ist­ics show that SME’s make up 99% of busi­nesses in the UK and these busi­nesses inject almost £1.9 trillion into the economy. However, one must also keep in mind that almost 50% of busi­nesses fail, and there are plenty of legal and bur­eau­crat­ic hurdles to overcome, as well as endless hard work to make your business a success.

Please note the legal dis­claim­er relating to this article.