Small Business Tax in United Kingdom

What taxes does a UK small business pay?

The taxes a UK small business faces depend on its legal structure. A private limited company pays corporation tax on profits, then its shareholders pay income tax on any salary or dividends extracted. A sole trader or member of a partnership pays income tax on trading profits plus Class 2 and Class 4 National Insurance contributions (NICs), all reported through the Self Assessment system. Both structures must register for VAT once taxable turnover crosses 90,000 pounds in any rolling 12-month period. For the full UK tax framework see the United Kingdom country overview.

The 1,000 pounds trading allowance is worth noting at the micro end: if gross trading or casual-service income in a tax year does not exceed 1,000 pounds, a sole trader typically does not need to notify HMRC or file a Self Assessment return. If income is above 1,000 pounds, the allowance can be deducted instead of actual business expenses -- but no other expenses may then be claimed in the same calculation. The trading allowance cannot be used against income from a company the trader controls or from an employer [SC5].

How does UK corporation tax work -- rates, marginal relief, and associated companies?

From 1 April 2023, the UK moved away from a single flat corporation tax rate to a three-band structure [SC1]:

• Small profits rate: 19 percent applies where annual taxable profits are 50,000 pounds or below.
• Main rate: 25 percent applies where taxable profits exceed 250,000 pounds.
• Marginal relief zone: Companies with profits between 50,000 pounds and 250,000 pounds pay at an effective marginal rate of 26.5 percent on the band above 50,000 pounds, tapering smoothly up to the 25 percent main rate. HMRC provides a free online marginal relief calculator at tax.service.gov.uk [SC1].

These rates and thresholds have been confirmed unchanged for the financial year beginning 1 April 2025 [SC2]. Both the 50,000-pound and 250,000-pound limits are reduced proportionately for short accounting periods and divided equally among associated companies -- businesses under common control. A company with one associated company has effective thresholds of 25,000 pounds and 125,000 pounds. This prevents profit-fragmentation across multiple small vehicles purely to access the lower rate [SC1].

Corporation tax is reported via the CT600 return, filed within 12 months of the accounting period end. Most small companies pay the full liability nine months and one day after the period end as a single payment. Companies with taxable profits above 1.5 million pounds pay quarterly under the Quarterly Instalment Payment regime.

How are sole traders and partnerships taxed?

Sole traders pay UK income tax on net trading profits in the same bands as employees [SC3]:

• Personal allowance: 12,570 pounds (no tax).
• Basic rate: 20 percent on profits from 12,571 pounds to 50,270 pounds.
• Higher rate: 40 percent on profits from 50,271 pounds to 125,140 pounds.
• Additional rate: 45 percent on profits above 125,140 pounds.

The personal allowance reduces by 1 pound for every 2 pounds of adjusted net income above 100,000 pounds, creating an effective 60 percent marginal rate between 100,000 pounds and 125,140 pounds.

On top of income tax, self-employed persons pay National Insurance. From 6 April 2024 the rules changed materially [SC4]:

• Class 2: Flat weekly contribution (3.50 pounds per week in 2025/26; 3.65 pounds in 2026/27). Profits must be at or above the Small Profits Threshold (6,845 pounds in 2025/26) for Class 2 to be due; those below may pay voluntarily to protect their State Pension record.
• Class 4: 6 percent on profits between the Lower Profits Limit (12,570 pounds) and the Upper Profits Limit (50,270 pounds), then 2 percent above the Upper Profits Limit. These rates were reduced from 9 percent and 2 percent respectively from 6 April 2024.

Both classes are paid through Self Assessment, with a payment-on-account system requiring estimated payments in January and July. Partners in an ordinary partnership each report their share on personal SA100 returns; the partnership itself files SA800.

The efficiency comparison between sole trading and incorporation changes as profits rise. Below roughly 40,000 pounds per year the administrative simplicity of sole trading generally outweighs any tax difference. Above that level, the corporation tax rate combined with lower-taxed dividend extraction often produces a lower combined liability -- but the analysis depends on individual circumstances and a qualified accountant or tax professional should model the options before any incorporation decision.

What is the VAT registration threshold and how does VAT work for small businesses?

VAT (Value Added Tax) at the standard rate of 20 percent is charged on most UK goods and services. A business must register for VAT if taxable turnover in any rolling 12-month period goes over 90,000 pounds, or if it expects to exceed 90,000 pounds in the next 30 days. This threshold was raised from 85,000 pounds on 1 April 2024. Registration must be completed within 30 days of exceeding the limit; the effective registration date is the first day of the second month after the limit was crossed [SC6].

Voluntary registration is available below the threshold and can benefit businesses whose customers are VAT-registered (who can reclaim the VAT charged) or where the business has significant input VAT to reclaim. The deregistration threshold is 88,000 pounds in a 12-month period.

Once registered, businesses must charge VAT on taxable supplies, submit VAT returns (usually quarterly), and keep digital records under Making Tax Digital for VAT -- mandatory for all VAT-registered businesses since April 2022 regardless of turnover. The Flat Rate Scheme simplifies accounting for businesses with turnover below 150,000 pounds by applying a single fixed percentage to gross turnover instead of tracking individual input and output VAT.

What is Making Tax Digital for Income Tax and when does it apply?

Making Tax Digital for Income Tax (MTD for IT) is a phased HMRC programme requiring sole traders and landlords to keep digital records and submit quarterly updates through MTD-compatible software, replacing parts of the annual Self Assessment return [SC7].

The rollout is income-threshold-driven:

• 6 April 2026: Sole traders and landlords with qualifying income over 50,000 pounds (assessed on the 2024/25 tax year) must comply.
• 6 April 2027: The threshold drops to qualifying income over 30,000 pounds (2025/26 tax year).
• 6 April 2028: The threshold is planned to fall further to 20,000 pounds (2026/27 tax year).

"Qualifying income" is the total gross income from self-employment and property before deducting expenses. Quarterly updates are not additional tax returns -- they are cumulative summaries of income and expenses submitted four times a year on fixed dates, with a final declaration replacing the current SA100 return at year end. HMRC provides free software for businesses with straightforward affairs; a wide range of commercial MTD-compatible packages also exists. Those who genuinely cannot use digital tools may apply to HMRC for an exemption.

Making Tax Digital for Corporation Tax remains in consultation and is not yet mandated for any filing date.

How does the dividend-versus-salary decision work for director-shareholders?

Owner-managed limited company directors commonly extract profits via a combination of a modest PAYE salary and dividends, because salary reduces corporation tax-taxable profits (it is a business expense) while dividends do not. However, dividends are paid from post-corporation-tax profits, so both layers of tax apply in sequence [SC8].

For 2026/27 (the tax year starting 6 April 2026), dividend tax rates changed under Finance Act 2026: the ordinary rate is 10.75 percent (basic-rate band), the upper rate is 35.75 percent (higher-rate band), and the additional rate remains 39.35 percent. The dividend allowance -- the amount of dividend income taxed at zero -- is 500 pounds per year [SC8]. For the 2025/26 tax year the ordinary and upper rates were 8.75 percent and 33.75 percent respectively.

A common practical pattern: set the salary at roughly the National Insurance Secondary Threshold (9,100 pounds in 2025/26) to keep the company clear of employer Class 1 NIC while still giving the director a State Pension-qualifying year, then draw dividends up to the basic-rate band limit. The efficiency of this approach changes with profit levels, the number of shareholders, whether the Employment Allowance is claimable, and individual circumstances. A qualified accountant or tax professional should model both extraction strategies before deciding -- the gap between sole-trader and director-shareholder effective rates narrows considerably above 100,000 pounds of income.