Tax and National Insurance

In order to calculate each partner’s liability to income tax and national insurance accounts are prepared each year. Those accounts should show the profit or loss for the year and, on the balance sheet, the assets and liabilities of the firm. The accounts should also reflect the capital each partner has tied up in the business, how much he has introduced, how much he has withdrawn, and so on.

Each tax year the firm itself must complete a tax return reflecting the accounts and showing how the profit or loss is split between the partners.

The firm’s accounts will be based on its accounting records and will reflect its income, expenses, assets and liabilities.

We are often asked what expenses are allowable for tax purposes but that is not an easy question to answer. Essentially, any expenses which you incur wholly and exclusively for business purposes are allowable. There are, however, certain items which cannot be deducted and if you have paid any such items they are added back to the profit in calculating the tax due. They are:

• Entertaining;
• Capital expenditure;
• Certain legal fees;
• Private expenses.

Capital expenditure covers things like computers, plant and machinery, office equipment, vans and cars. In this case these are treated as assets and capital allowances can be claimed.  Details of the rates and deductions available are set out elsewhere on the website.

Where cars are also used privately, a proportion of the running costs is added back to the profits and tax is payable on the increased figure. Similarly, capital allowances are restricted for such cars.

The cost of uniforms and protective clothing are allowable but not the cost of a suit or dress, even if only used for work.

If you run a business from which you habitually take goods for your own use (such as a pub or a restaurant) an adjustment is also made to account for that as you cannot claim tax relief for your own subsistence.

Travel to and from business meetings is allowable, though care must be exercised about hotel bills and if a spouse or partner (that is, a personal partner, not a member of the firm) accompanies you.

Each partner is liable to pay two types of national insurance, called Class 2 and Class 4. Class 2 contributions are usually paid by direct debit on a monthly basis and are at a flat rate. Class 4 contributions are based on profits and are payable at the same time as income tax. Rates can be found in the Reference section of the website.

Each year after starting business the partners must pay tax and national insurance on their shares of the firm’s profits. Whilst it is quite common for the firm itself to pay that tax and national insurance on behalf of the partners, they are obligations of the individual partners, not the firm itself.

You can refer to the section on Sole Traders to see what tax and national insurance is payable by each of the partners.

Although tax and national insurance is worked out on the tax-year basis, most firms do not make up their accounts to 5 April each year. Instead, they use some other date (normally the anniversary of starting to trade).

Once the firm’s tax return for a year has been prepared each partner is provided with a copy of page showing how the profits have been split. That page forms the basis on which each partner makes entries in his own self assessment return.