All beginnings are difficult - this also applies in setting up a business. Luckily, there are three special schemes where small businesses have an exception for all things accounting, including registering as VAT exempt. However, the status of a small business is not always helpful, and in some cases it may help to register for VAT even if you’re not obliged to – check out the pros and cons.
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.
What is 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
Registering your name
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.
Tax and accounting requirements
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.
Small business tax obligations
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.