Small Business Tax in the UK Explained Simply
(A Practical Guide for Beginners)
Introduction
Starting a small business in the UK can be exciting — but tax is often the part that causes the most confusion.
Income tax.
National Insurance.
VAT.
Allowable expenses.
Deadlines.
It can quickly feel overwhelming if you’ve never dealt with it before.
The good news is that small business tax is actually quite structured once you understand the basics.
This beginner-friendly guide explains how it works — clearly and simply — so you know what to expect and how to stay organised.
Contents
- What Type of Business Are You?
- How Sole Trader Tax Works
- What Taxes Sole Traders Pay
- When You Pay Tax
- Allowable Expenses Explained
- How Much Tax to Set Aside
- VAT Thresholds
- Limited Company Tax Basics
- Making Tax Digital
- Common Tax Mistakes to Avoid
- Frequently Asked Questions
- Official Guidance
- Final Thoughts
1. First, What Type of Business Are You?
Your tax responsibilities depend on your structure.
Most new businesses start as:
Sole Trader
Limited Company
This guide focuses mainly on sole traders, because that’s where most beginners begin.
(If you run a limited company, corporation tax applies instead — which we’ll briefly touch on later.)
2. How Sole Trader Tax Actually Works
As a sole trader, you pay tax on profit, not revenue.
This is the first thing many people misunderstand.
Revenue = total money you receive
Profit = revenue minus allowable expenses
You only pay tax on the profit.
For example:
If you earn £40,000 And have £10,000 in legitimate business expenses.
Your taxable profit is £30,000.
That £30,000 is what tax is calculated on.
3. What Taxes Do Sole Traders Pay?
You’ll usually pay:
Income Tax
Based on your total taxable income (including other income like employment).
National Insurance Contributions (NICs)
These depend on your profit level.You report both through a Self Assessment tax return.
4. When Do You Pay Tax?
The tax year runs from:
6 April to 5 April
You submit your Self Assessment return by:
31 January (following the end of the tax year)
Tax is usually paid:
31 January
31 July (payment on account, if applicable)
The key point:
You are paying tax after you’ve earned the money — not monthly through PAYE like employment.
That means responsibility shifts to you.
5. What Are Allowable Expenses?
Allowable expenses reduce your taxable profit.
Common examples include:
Business equipment
Software subscriptions
Marketing costs
Office supplies
Business travel
A portion of home office costs (if applicable)
If an expense is “wholly and exclusively” for business purposes, it is usually allowable.
Keep clear records. Digital records are best — and will soon become essential as the new Making Tax Digital rules begin to take effect from April 2026.
6. How Much Should You Set Aside?
This is one of the most important practical questions.
There isn’t one universal percentage.
But many sole traders set aside: 20–30% of profit as a starting point.
If your income rises into higher tax bands, that percentage should increase.
The safest approach:
Treat tax money as not yours.
Move it into a separate account regularly.
7. What About VAT?
In the UK, you must register for VAT if your taxable turnover (the total value of everything you sell that isn’t exempt from VAT) exceeds £90,000 in any rolling 12-month period.
This threshold has been in place since 1 April 2024 and applies to the 2025/26 and 2026/27 tax years unless the government announces a change.
Once you exceed £90,000:
You must register for VAT with HMRC within 30 days.
After registration you’ll charge VAT on your sales and send regular VAT returns.
Below that level, VAT registration is optional — some businesses choose to register early for specific reasons, but it’s not required until turnover exceeds £90,000.
8. If You Run a Limited Company
Limited companies pay:
Corporation Tax on profits (currently between 19% and 25% depending on profit levels).
Directors then pay Income Tax on any salary or dividends they take from the company.
This structure adds complexity and administrative responsibilities.
For many beginners testing an idea, sole trader status is usually simpler.
9. What Is Making Tax Digital?
From April 2026, many self-employed individuals earning over £50,000 will move to digital quarterly reporting under Making Tax Digital for Income Tax.
In simple terms, this means sending more frequent updates to HMRC using approved software.
Importantly, this changes how often you report income — not how much tax you pay.
(You can read more about this in the dedicated Making Tax Digital guide.)
10. The Biggest Mistakes to Avoid
Most small business tax stress comes from:
• Leaving bookkeeping until January
• Not separating personal and business money
• Spending tax money accidentally
• Not understanding profit vs revenue
Tax itself is predictable.
Poor record-keeping is what creates panic.
11. Frequently Asked Questions
1. Do I pay tax on all the money my business earns?
No. You pay tax on your profit, not your total revenue.
Profit is what’s left after you deduct allowable business expenses from your income.
2. How much tax should I set aside as a sole trader?
There isn’t one fixed percentage, but many sole traders set aside 20–30% of their profit as a starting point.
If your income rises into higher tax bands, you may need to increase that.
Keeping tax money in a separate account helps avoid stress later.
3. When do I need to register for VAT?
You must register for VAT if your taxable turnover exceeds £90,000 in any rolling 12-month period.
Below that level, VAT registration is optional.
4. What counts as an allowable expense?
An expense is usually allowable if it is wholly and exclusively for business purposes.
Common examples include software, equipment, marketing costs, travel for business, and a portion of home office costs (if applicable).
Keeping clear digital records makes this much easier.
5. Do I have to pay tax four times a year under Making Tax Digital?
No. Making Tax Digital changes how you report your income (quarterly updates), not how often you pay tax.
The annual final declaration still applies.
6. What happens if I don’t set money aside for tax?
If you spend money that should have been saved for tax, January can become extremely stressful.
Tax bills don’t disappear — they simply arrive later.
Regularly setting aside a percentage of profit prevents panic and protects your cash flow.
12. Official Guidance
For up-to-date information, always check:
https://www.gov.uk/self-assessment-tax-returns
https://www.gov.uk/set-up-sole-trader
Government rules can change, so it’s worth confirming details directly.
13. Final Thoughts
Small business tax in the UK isn’t designed to trap you.It’s structured.Once you understand:
• Profit vs revenue
• What expenses are allowable
• When payments are due
• How much to set asideIt becomes manageable.
Clarity reduces anxiety.
And steady record-keeping prevents problems long before they start.
You don’t need to become an accountant.
You just need to stay organised, review regularly, and keep your systems simple.
If you found this post helpful you may also be interested in reading the following articles too:
Articles
← How to Start a Small Business in the UK (A Practical Step-by-Step Guide)
← Simple Business Ideas You Can Start From Home
← What Passive Income Really Is (And What It Isn’t)
← Making Tax Digital in April 2026: What Small Businesses Need to Know
← How to Prepare for Making Tax Digital (Simple Step-by-Step Guide)
← AI for Small Business: 10 Prompts That Could Save You Time, Money and Costly Mistakes