Entrepreneurs often believe certain tax myths, perpetuated by well-meaning friends, and what they have heard in the pub etc. The Business Lounge separates the facts from the fiction.

I can claim this lunch as a business expense

As a business, you will pay tax on your profits, very roughly, your income less your costs, but not all your costs can be deducted here when working out what your profits are for these purposes – see our article on “Tax Deductions”. A common mistake is to assume that taking clients out for lunch/drinks, will give you tax relief by reducing your profits, but it won’t, so take care next time you flash the cash.

If the taxman doesn’t know about it, that’s his problem

You may have a mainstream business but do some other linked (or completely different) work for cash. If this is never declared, you may think you won’t have to pay tax on it. Wrong. You have a legal responsibility to declare all forms of income on your tax return, and in fact, are required to inform HM Revenue & Customs when new sources of income arise. Failure to do this is tax evasion, a criminal offence.

If you’ve not been doing this, the head-in-the-sand approach is not advised. Seek advice from your accountant or tax adviser, as disclosure to HM Revenue & Customs (with the advice and support of your adviser) can help reduce the consequences. There will still be penalties (and interest) to pay.

I can do what I like with the money from my business

As a sole trader, you can take drawings from your business. As for business entertaining, these won’t be tax deductible. The situation is very different if you have set up a company as you individually and the company, are two separate entities. Therefore, to take money from the company, you would have to pay yourself as an employee, or declare a dividend. Both have tax consequences. You should ask your accountant what is the most tax efficient and suitable way to extract money from your company. If you don’t actually pay a salary or dividend, but take money from the company, this will be a loan to you. Strictly, loans to directors are illegal in most circumstances, although private companies do sometimes have these. Again, there are tax consequences, and you should discuss this with your accountant.

I don’t want to pay corporation tax at higher rates, so I’ll set up another company to split the profits

The rate at which your company will pay corporation tax, depends on the level of profits in the company. If a company’s profits are growing, then to avoid hitting higher tax rates, some owners run part of their business activities through another company. This does not work, as the levels at which different rates set in, take into account how many companies you own. See our article on “Corporation tax rates”.

And don’t think to put your second company in your wife/husband’s name instead, as that doesn’t work either.

Passing on business knowledge is vital to help encourage new entrepreneurs, but be careful what you believe. And, of course, if it seems like a good tax wheeze, then there are probably rules against it.

As with all our information in The Business Lounge, this is not comprehensive tax advice and may not apply to your specific circumstances; to discuss how these issues affect you, contact your accountant.