Taxation of Unincorporated and Incorporated Entities
Unincorporated businesses
Sole traders and partnerships are taxed on trading profits through self assessment. Partners are taxed individually on their share of partnership profits. Understand basis periods, the cash basis, and the treatment of drawings (not deductible) versus salaries to partners (deductible if genuine). National Insurance contributions apply to the self-employed under Class 2 and Class 4 rules.
Incorporated businesses
Companies pay corporation tax on taxable total profits, which include trading profits, property income and chargeable gains. Corporation tax rates depend on the level of profits and the marginal relief rules. Directors' remuneration is deductible for the company but taxable for the director; dividends are paid from post-tax profits and taxed on the shareholder. Understand the interaction of salary versus dividend planning and the associated National Insurance.
Close companies and traps
Close companies have specific rules on loans to participators and distributions. Traps: deducting drawings as an expense; treating a partner's salary as automatically allowable; forgetting corporation tax on chargeable gains; confusing the tax treatment of salary and dividends; ignoring the effect of associated companies on corporation tax rates.
Worked rule
Rule of thumb: for a company, compute trading profit, deduct allowable expenses including directors' salaries and employer NIC, then apply corporation tax. For a sole trader, compute tax-adjusted trading profit, deduct capital allowances, then apply income tax and Class 4 NIC.
Worked example: A company has profits of £120,000 after deducting a director's salary of £30,000 and employer NIC. Corporation tax is computed on the taxable profits at the applicable rate, with marginal relief where relevant. The director pays income tax and NIC on the salary, and any dividend is taxed separately. By contrast, a sole trader with the same profit pays income tax and Class 4 NIC on the trading profit, and drawings are not deductible.