Taking a Toll

TAKING A TOLL:

Small businesses and the cost of tax compliance

Published: April 2025 fsb.org.uk

Taking a Toll: Small businesses and the cost of tax compliance

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ACKNOWLEDGEMENTS This report was written by Andrea Macleay, Senior Policy Advisor.

Special thanks to all those in FSB’s media, government affairs and policy teams in Westminster, Scotland, Wales and Northern Ireland who provided insight and support, in particular Paul Wilson, Policy Director; Jo Tacon, Media and Communications Officer; Tom Blenkinsop, Senior Government Affairs Advisor; and Kanya Paramaguru, Senior Policy Advisor. Special thanks to FSB Policy Chair for Tax and Finance, Tony Baron, and Policy Champion for Finance and Banking, Robin Abrams.

Thanks also to the FSB members on our tax committee: Robin Abrams, Tony Baron, Kevin Bragg, Sue Cave, Andrea Knox, Simon Oakes, and Jackie Petherbridge.

Thank you also to all the FSB members and other small businesses and the self-employed who took the time to engage with our research which underpins this report. The quantitative research was carried out by Verve – the market research agency responsible for administering the survey. The report was designed by Cactus Design Limited – a small business based in Wales.

WHO WE ARE The Federation of Small Businesses (FSB) is the UK’s grassroots business organisation.

We are a cross-party non-profit body that represents small business and self-employed members in every nation and region. In 2024, FSB celebrated 50 years of being the authoritative voice on issues affecting the UK’s 5.5 million small businesses, microbusinesses and the self-employed.

FSB is the UK’s largest business group and leading business campaigner, focused on achieving change which supports smaller businesses to grow and succeed. We also provide our members with a wide range of vital business services, helping them to start, run, and grow successful businesses through high quality protection and support. This includes 24/7 legal support, financial expertise, training and events, debt recovery and employment/HR advice – alongside a powerful voice heard by governments at all levels.

Our local, national and international activity helps shape policy decisions that have a direct impact on the day-to-day running of smaller businesses. We work for their interests through research and engagement with our members and by effective campaigning - informing those in power through policy analysis, government affairs, international engagement, and media, communications & public relations. Our advocacy work starts with our expert external affairs team in Westminster, which focuses on UK and England policy issues, the UK Government, Parliament and media and communications engagement. Further to this, our teams in Glasgow, Cardiff and Belfast work with governments, elected representatives and media in Scotland, Wales and Northern Ireland.

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CONTENTS Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Infographic: Taking a toll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Key findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Tax administration and compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Costs of tax compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Methods of business transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Small businesses and HMRC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Contacting HMRC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 HMRC experiences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Making Tax Digital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Tax reliefs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 How tax reliefs grow the economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

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FOREWORD The imbalance of power between the typical small business and HMRC, with its power to investigate, levy penalties, and prosecute, is immense. As recent high-profile examples demonstrate all too clearly, in any situation where there is such an enormous mismatch in everything from legal firepower to internal resources, there is the potential for equally outsized injustices and failures of oversight.

Little wonder therefore that the small business owner or self-employed person approaches filling in their tax returns with trepidation. Tax compliance is thorny, time-consuming, and fraught with anxiety. Trying to engage with HMRC to obtain guidance or a response to an appeal can be immensely frustrating, with the tax authority often failing to answer telephone calls or letters in a timely manner.

The mental burden weighing on small business owners as a result of the tax system must not be underestimated, either, with three in five saying that dealing with HMRC has increased their personal stress. Running your own firm is hard and emotionally taxing enough without adding in scarily-worded letters from HMRC due to an innocent mistake, or the nightmare of trying to get through to someone who has the power to help with a query with even the slightest degree of complexity to it.

The tax system that businesses have to engage with is far more complex and unwelcoming than it needs to be, and has resisted attempts for it to be touched or shaped in any way by the new Government’s very welcome agenda for growth, which, by contrast, is now informing almost every other public authority. The average small business owner spends 44 hours and £4,500 a year on tax compliance, an increase of around 10 per cent since 2021.

Reducing the staggering amounts of time and money that small firms collectively spend on tax compliance – over 27,000 years and nearly £25 billion respectively per annum – by even a few percent would deliver huge savings and help to improve productivity levels.

Every hour a business owner spends trying to get an answer out of HMRC is an hour that cannot be spent developing their business.

The landscape for paying tax in the UK is changing, as the Government steps up its efforts to persuade small businesses to switch over to the Making Tax Digital (MTD) programme.

Three in five small firms have already made the switch to MTD, but three in 10 do not know when they plan to adopt MTD-compatible software – illustrating a stark digital divide, and a clear sign that HMRC must tread carefully with its timetable and plan for digital adoption.

The price of MTD-compatible software must also be scrutinised to so that that small businesses do not end up trapped paying high subscription costs for something they need in order to comply. Allowing for easy switching of providers may help encourage downward pressure on costs.

HMRC is now in the process of recruiting 5,000 new compliance officers to reduce the 'tax gap' by £5 billion, and is also recruiting an additional 1,800 debt management staff. These new staff need to be properly trained to follow HMRC's Charter, to treat taxpayers fairly, and to follow procedural safeguards, while taxpayers should be fully informed of their rights.

The desire to close the 'tax gap' should not result in an excessively heavy-handed and threatening approach to small businesses.

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HMRC’s stated objective is to build a “trusted, modern tax administration system”.1 In order to do so, it needs to remember that trust is a two-way street. The overwhelming majority of small business owners want to pay the correct amount of tax. Many do not claim all the reliefs they are entitled to, because they lack the necessary knowledge of the tax system and often cannot afford tax advice, and because the system as currently designed does not prompt them to claim applicable reliefs.

Where business owners are given clear, timely guidance, not only will their anxiety levels be reduced, but the productivity of the tax system will improve. Making customer services more efficient and more responsive would reduce inadvertent error and improve the tax take more than making tax compliance more draconian would do. We would also encourage HMRC to adopt a duty of candour, as we called for in a recent letter to HMRC. The benefits of reducing the toll taken by tax compliance on small business owners’ balance sheets, diaries, and stress levels would be huge both in human quality of life terms, but also economically for growth and productivity.

Tony Baron Policy Champion, Tax and Finance Federation of Small Businesses

1

https://www.gov.uk/government/publications/tax-administration-strategy/building-a-trusted-modern-taxadministration-system 5

Taking a Toll: Small businesses and the cost of tax compliance

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INFOGRAPHIC: TAKING A TOLL TAKING A TOLL:

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Small businesses and the cost of tax compliance

TAX ADMINISTRATION AND COMPLIANCE CONTINUES TO BE A BURDEN

Small businesses spend on average

44 hours

per year on tax compliance, equating to 242 million hours in total

Small businesses spend on average

£4,500

a year on tax compliance, an increase of around 10% from £4,100 in 2021

85%

of small businesses use an intermediary to help them with their tax

HMRC MUST TAKE IMMEDIATE STEPS TO IMPROVE ITS CUSTOMER SERVICES AND OPERATIONS

52%

of small businesses disagreed that HMRC was accessible to contact

60%

of small businesses say dealing with HMRC has resulted in increased personal stress

Only

63%

of small businesses with turnover above £50,000 feel prepared for the first phase of Making Tax Digital for income tax, commencing in April 2026

TAX RELIEFS PROVIDE VITAL SUPPORT AND ENCOURAGE GROWTH

95%

of small businesses who claimed Small Business Rate Relief stated it was valuable to their business 6

73%

of small businesses intend to use the additional capital from tax reliefs for investment purposes

93%

of small businesses who claimed Employment Allowance stated it was valuable to their business

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KEY FINDINGS Small businesses use the following sources of information to help them with tax compliance: • 85 per cent use an intermediary, such as a tax accountant, agent or adviser • 58 per cent use gov.uk or HMRC web resources • 35 per cent of respondents rely on the Federation of Small Businesses.

As taxpayers, small businesses often need to interact with HMRC: • 60 per cent say dealing with HMRC has resulted in increased personal stress • 52 per cent disagreed with the statement that HMRC was accessible to contact • 68 per cent used the phone to contact HMRC in the last two years, making it the most popular method of contact. However, only 23 per cent of this group rated the experience as good • 37 per cent of small businesses used webchat, making it the least common method of contact, and of this group, 19 per cent rated this experience as good.

Small businesses are preparing for Income Tax Self-Assessment (ITSA), the next stage of Making Tax Digital (MTD): • 63 per cent of small businesses with turnover larger than £50,000 already use MTD-compatible software • 27% per cent of small businesses above the MTD threshold do not know when they plan to adopt MTD-compatible software.

Tax reliefs are essential to small businesses and can assist small businesses achieve economic and social objectives. In the past two years: • 95 per cent who claimed Small Business Rate Relief stated it was valuable to their business • 92 per cent of those who claimed the Employment Allowance stated it was valuable to their business • 32 per cent claimed Dividend Allowance, with 81 per cent stating it was valuable to their business • 19 per cent claimed pension tax relief, with 91 per cent stating it was valuable to their business.

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RECOMMENDATIONS HMRC should: • Enforce shorter timescales to provide responses to taxpayers and publish the outcomes each year in its annual report. FSB recommends that HMRC should meet the performance standards it has set internally for most tax queries, which is a response time of 15 days and a statutory limit of 30 days. HMRC should deploy additional resources, including a portion of the funding committed by the Government to address compliance, to clear the current backlog and bring down the waiting times for responses. For example, at the time of publication, if a small business registers for VAT, HMRC’s interactive response guidance states that an application submitted should expect a reply six weeks later. This is three times more than its performance target.

• Impose a duty of candour on HMRC’s tax compliance officers. This will require officers to be open and honest about mistakes, and to inform a small business owner under investigation of their rights within the tax investigation process at the outset as well as the full consequences of any concessions made.

Small businesses are often unaware they can utilise the service of professional accountancy services and specialists to help guide them through the HMRC process, and even deal with HMRC on their behalf. A duty of candour will help prevent poor treatment of taxpayers by public officials and help build trust between tax collector and taxpayer.

• Review and design tax investigator performance incentives so that incentives are focused on a fair investigation and not disproportionately weighted towards revenue maximisation at the cost of a fair process. Tax investigators should adhere to a code of conduct and that due process is followed as a priority.

HMRC should base performance incentives on fairness in processes, rather than on greatest revenue recovered.

• Set a time limit on the length of HMRC tax investigations, while investigations that go over the time limit period will need strong justification for doing so.

Currently, full enquiries on average can take up to 18 months to finish; however, this is not strictly enforced, and some small businesses have undergone tax investigations that have taken years to be resolved, which comes at a cost of great financial and emotional stress, but also limits HMRC resources. Once an appropriate time limit has been set, FSB would call for this to be enforced by the tax tribunal, unless HMRC can provide strong justification for the reason why a tax investigation has taken longer than usual.

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• Increase the visibility of the section labelled ‘tax reliefs’ on self-assessment tax returns, and for online forms, include a pop-up or reminder to encourage taxpayers to check if they need to fill in this section if they have not done so.

For example, 48 per cent of self-employed people are saving into a pension, but only 19 per cent use pension tax relief. If a self-employed person earns £50,000 or more, paying income tax at 40 per cent, they are eligible to claim an extra 20 per cent tax relief on their self-employed pension through their Self-Assessment Tax Return, in the section labelled ‘tax reliefs’. Government must increase awareness of this benefit, and of similar available reliefs, in order to improve uptake levels.

• Set a target to reduce business administration costs by a third by 2028. FSB calls for HMRC to eliminate unnecessary and redundant processes, streamline operations, and improve customer services to work towards reduced business administration costs. HMRC should set a target to track this cost, and publish annual updates. HMRC could make a significant contribution to the Governmentwide target of reducing administrative costs for all businesses by 25 per cent.

With FSB estimating the average tax compliance cost to a small business in 2024 was £4,500, aiming to bring this down to £3,000 can be achieved, alongside increasing the availability of low-cost options for Making Tax Digital for Income Tax Self-Assessment (ITSA)-compliant software. The average cost of tax compliance for small businesses has increased by 10 per cent since 2021, when it was £4,100.

• Pursue the objective of economic growth in carrying out all of its functions. As part of the ‘regulating for growth’ agenda, numerous government regulators have growth duties. As a key touchpoint for small businesses, HMRC should have a similar duty.

• Only promote e-invoicing through voluntary standards if Government intervention is necessary, not through mandating it. This will allow small businesses to choose their preferred method for invoicing (e.g. digital or paper) without being mandated to adopt it and bear the costs associated with additional regulation.

• Review the pricing of Making Tax Digital compliant software as part of the evaluation of the programme, and if needed introduce regulation to limit price increases. With small businesses mandated to comply with Making Tax Digital for Income Tax from 2026 and 2027, many small businesses will be signing up for MTD software for the first time, and given their small size, could be reliant on regulatory protections so that they are not subjected by software providers to excessive and unavoidable price increases. This could include promoting fair and easy switching between software providers as a means of encouraging downward pressure on costs.

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• Set a specified time-limit as to how long refunds from HMRC should take.

Where HMRC legislates that payments by taxpayers should be paid within a certain timeframe, it would be good to see HMRC observe the same standard by making refunds also by a specified timeframe. Businesses often complain of having to wait months on end for refunds from HMRC. • Improve the accessibility of HMRC services. HMRC’s services and communications channels must be tested for accessibility, to ensure they work equally well for taxpayers who are neurodivergent, and providing alternative channels of communication where needed.

The National Audit Office or the Adjudicator’s office should: • Undertake audits of HMRC investigations to check that investigators are following due process. This would encourage a higher standard for tax investigators to maintain, so that small businesses experience a fair investigation.

Many small businesses do not have the time, resources or money to review a HMRC tax investigation or take HMRC through to a tribunal to dispute a tax investigation.

HM Treasury should: • Commit to making National Insurance contributions relief for hiring veterans a permanent measure. At the 2024 Autumn Budget, the Government announced it would extend the employer National Insurance contributions relief for employers hiring qualifying veterans for a further year, until 5 April 2026. Alongside X-Forces, FSB was the original co-designer of this policy idea, which we continue to support strongly. If agreed, FSB would run an awareness-raising campaign to ensure that this important change was promoted to small employers in all local communities. This scheme should be made a permanent measure, allowing small businesses to continue to pay no employer NICs up to annual earnings of the Veterans Upper Secondary Threshold of £50,270 for the first year of a veteran's employment in a civilian role.

• Increase the eligibility threshold for Small Employers’ Relief. FSB proposes two options for the Government to consider: – Option 1: Retain the threshold for Small Employers Relief at £45,000 or less Class 1 NICs, but with the Employment Allowance reduction applied. This means a small business can have a National Insurance bill of up to £55,500, apply the Employment Allowance to bring their bill down to £45,000, and claim the Small Employers' Relief.

– Option 2: Increase the threshold for Small Employers' Relief from £45,000 to £100,000. This would be in line with the previous Employment Allowance threshold, where businesses with National Insurance contributions of up to £100,000 were classed as small businesses.

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• Maintain the Business Asset Disposal Relief (BADR) rate at 14 per cent going forward. The relief provides hard-working small businesses incentives to continue to invest and expand their business; the additional capital saved as a result from the relief can be used for entrepreneurial decisions such as selling a business or reinvesting, or for those who have worked many years, often without pension savings, to be able to fund their retirement. The amount of tax paid by business owners relying on BADR has already increased by 40% in 2025. Over four-fifths (83%) of small businesses plan to use BADR in the future if eligible, with almost all (94%) of those in the accommodation and food services industry planning to do so.

All small employers should: • Check that they are correctly claiming the Employment Allowance in order to gain a £10,500 reduction on their Employer National Insurance contributions in 2025/26. Small businesses can claim at any point during the tax year as part of their Real Time Information (RTI) submission to HMRC.

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TAX ADMINISTRATION AND COMPLIANCE By nature of their size, small businesses often have neither the capacity nor the expertise to manage their entire operations in-house, particularly tax administration. FSB’s survey found the great majority of small businesses – 85 per cent – use a tax accountant, agent or advisor when completing or filing their tax returns or required tax obligations. Small businesses are often reliant on the advice of their tax accountant to navigate an increasingly complex tax system and the challenges of HMRC’s customer service systems.

Levels of intermediary use vary by sector: 97 per cent of accommodation and food services firms and 95 per cent of construction businesses use an intermediary for their taxes. By contrast, although still high, 77 per cent of professional, scientific and technical activities use an accountant, agent or advisor, the lowest of all sectors. It is worth noting that accountancy and financial advice falls into this sector and these small businesses may have the expertise to complete their own returns.

For small businesses going solo and handling their own tax administration, 12 per cent reported they file or complete their tax obligations on their own. For small businesses with no employees (i.e. the self-employed), this is doubled at 23 per cent. Businesses with no employees may be motivated to do their own returns to save on the cost of hiring an accountant, or may have less complex tax obligations to fulfil if they have no PAYE employees or claim no tax reliefs. Solo filing is also significantly higher in certain sectors: 21 per cent of professional, scientific and technical businesses and 17 per cent in the information and communications sector complete their tax files themselves. Over a quarter (28%) of the professional, scientific and technical sector have claimed no tax reliefs in the past two years, reducing the complexity of their tax returns and meaning they are more likely to go it alone.

Many small businesses use the official Government websites of HMRC and GOV.uk at 58 per cent, and the Federation of Small Businesses at 35 per cent. The remaining – and very small – percentage of small businesses get a friend or family member to do their tax return for them, or they have an in-house resource (e.g. member of staff) to fulfil their business tax filing obligations.

I’m not time-poor, I do have the time to do new things but what I don’t have time for is to learn tax law. I would rather outsource for my accountant to get everything right, submit correctly and be able to claim back what I can. This gives me my time back to generate the income for my business and have someone else take over the tax side, to ensure the business stays profitable.

FSB member, Information and Communications, East Midlands

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Figure 1: Where do you go to find information or advice about tax for your business?

Source: FSB Tax Survey 90% 85% 80%

70%

60%

58%

50%

40% 35% 30%

20%

10% 6%

0%

Tax accountant/ agent / adviser

HMRC and/or GOV.UK

Federation of Small Businesses

5%

Intermediary Other business/ non-certified or membership non-chartered organisations accountant/ agent/adviser

5%

Via friends or family

3% Valuation Office Agency

Small businesses with 10-49 employees (90%) and micro-businesses with 1-9 employees (84%) are more likely to seek external advice from an intermediary, compared to those who are self-employed/no employees at 71 per cent (figure 2). Those with no employees are more likely to use official government websites, such as GOV.uk or HMRC. Despite a high percentage who receive tax advice from government websites, small businesses have noted the difficulty they encounter in finding information which is presented in a digestible format.

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Over a third of small businesses (35%) surveyed use the Federation of Small Businesses (FSB) website and member services to find information and advice about tax. Small businesses are likely to engage with advice which relates to their business.

Figure 2: Where do you go to find information or advice about tax for your business? (By number of employees) Source: FSB 2024 Tax Survey 100% 90%

90%

84%

80%

70%

71% 63%

60%

57% 66%

50%

40%

37% 32%

34%

30%

20%

10%

7% 7% 3%

0%

Intermediary certified or chartered tax accountant/ agent/adviser

HMRC and /or GOV.UK

Federatio of Small Businesses

None

14

5% 6% 5%

7%

5% 4%

4%

6%

0%

Intermediary - Other business non-certified or / membership non-chartered organisations, accountant/ please specify agent/adviser

1-9

10-49

Via friends or family

Valuation Office Agency

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Costs of tax compliance In 2024, the average small business spent £4,500 a year on tax compliance. This is an increase of £400 from the equivalent figure from FSB’s 2021 report A Duty to Reform,2 which found that small businesses were spending on average £4,100 a year on tax compliance (figure 3). The £400 increase between 2021 and 2024 is however lower than the expected cost of £4,900, had compliance spend risen in line with the consumer price index.

Factors that may have contributed to the higher cost of compliance could include increases in the prices of accounting software subscriptions or packages, higher hourly charges from accountants, and a need for more specialised and individual advice as the tax code became more complex over the period in question.

Filing an R&D [research and development] tax credit claim with HMRC is very complex. As HMRC likes to point out, there is a lot of error in small claims. I believe that’s because of this complexity. This year I filed my own R&D tax claim for generative AI for £1,600.

I sent my claim to HMRC in the post. It was returned because R&D forms must be filed online instead. Filing online is itself complicated and requires the use of accountants who have relevant permissions, but I was rejected by a number of accountants because they don’t want the time and stress of filing R&D claims unless it’s a claim for a significant amount.

Eric Feltin, South East, Professional, Scientific, and Technical activities Figure 3: Cost of tax compliance for small businesses across Britain Source: FSB 2024 tax survey and FSB 2021 report ‘Duty to Reform’

Nation

The average small business’s cost of tax compliance in 2024

The average small business’s cost of tax compliance in 2021

Difference between 2024 and 2021

England

£4,470

£4,050

£420

Scotland

£4,910

£4,540

£370

Wales

£3,980

£3,800

£180

UK average*

£4,500

£4,100

£400

* Northern Ireland data is included in the UK average but there is no breakdown for Northern Ireland due to insufficient sample size.

2

SB: A Duty to Reform: Making tax work for small businesses in a digital world, October 2021, https://www.

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Figure 4: Cost of tax compliance for small businesses (By number of employees) Employee size

The average small business cost of tax compliance in 2024

None

£1,970

1-9

£4,390

10-49

£7,940

There is a relationship between a business’s number of employees and its cost of tax compliance (see figure 4). This likely reflects that small businesses with employees have to take on the additional costs of managing PAYE and National Insurance contributions, as well as likely higher turnover and profits, meaning that more taxes are relevant.

Small businesses’ tax compliance costs increase with higher profits. Small businesses with profits under £50,000 pay an average tax compliance cost of £3,160. By comparison, small businesses with profits between £50,001 and £250,000 have an average tax compliance cost of £5,510, while small businesses with profits greater than £250,000 have an average tax compliance cost of £7,940.

During Covid, I deregistered my business from VAT: turnover was down, and it reduced the complexity of running my business. My business has now picked up, and I’ve changed my focus from consulting to providing product and tech solutions for ESG [environmental, social and governance] initiatives. I wanted to re-register my business again but could only do so with a new VAT number. It would be much more efficient if HMRC would let me re-register with my old VAT number as this would be a faster process and less costly to update.

FSB member, ESG consultant, London FSB research shows that in 2024, the average small business spent 44 hours a year on tax compliance and administration, down from 52 hours in 2021. One factor driving the reduction in time has been the increased uptake of digital services such as accounting software. Although subscription increases from accounting software have increased small businesses’ costs, they have reduced the number of hours spent undertaking tax compliance. Accounting software can automate tasks such as data entry, calculations, report generation and accounts production, reducing the need and time for manual entries.

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Caution, however, must be exercised. The Administrative Burdens Advisory Board (ABAB), an independent board of business experts providing business insight and expertise to HMRC, highlighted potential time increases when HMRC’s Making Tax Digital (MTD) for Income Tax Self-Assessment (ITSA)takes effect from 2026 (see MTD section for more detail). One-third (33%) of survey respondents say time costs will increase significantly due to submitting quarterly updates and keeping digital records.3 With an estimated 5.5 million SMEs in the UK, and an average cost of compliance at £4,500, the overall cost of tax compliance for small businesses comes in at £24.8 billion. And with the average small business spending on average 44 hours per year on compliance, the small business population spends a collective 242 million hours on handling its tax liabilities each year.

Despite the overall reduction in hours spent on tax compliance by small businesses since 2021, it remains a significant drain on the UK economy and productivity, as the time and money it swallows up could be much better utilised for productive purposes, such as growing and scaling a business.

3 https://www.gov.uk/government/publications/administrative-burdens-advisory-board-tell-abab-report-2023to-2024/tell-abab-report-2023-to-2024#hmrc-communications-and-engagement 17

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Recommendations HMRC should: • Set a target to reduce business administration costs by a third by 2028. FSB calls for HMRC to eliminate unnecessary and redundant processes, streamline operations, and improve customer services to work towards reduced business administration costs. HMRC should set a target to track this cost, and publish annual updates. HMRC could make a significant contribution to the Governmentwide target of reducing administrative costs for all businesses by 25 per cent.

With FSB estimating the average tax compliance cost to a small business in 2024 was £4,500, aiming to bring this down to £3,000 can be achieved, alongside increasing the availability of low-cost options for Making Tax Digital for Income Tax Self-Assessment (ITSA)-compliant software. The average cost of tax compliance for small businesses has increased by 10 per cent since 2021, when it was £4,100.

• Pursue the objective of economic growth in carrying out all of its functions. As part of the ‘regulating for growth’ agenda, numerous government regulators have growth duties. As a key touchpoint for small businesses, HMRC should have a similar duty.

• Enforce shorter timescales to provide responses to taxpayers and publish the outcomes each year in its annual report. FSB recommends that HMRC should meet the performance standards it has set internally for most tax queries, which is a response time of 15 days and a statutory limit of 30 days. HMRC should deploy additional resources, including a portion of the funding committed by the Government to address compliance, to clear the current backlog and bring down the waiting times for responses. For example, at the time of publication, if a small business registers for VAT, HMRC’s interactive response guidance states that an application submitted should expect a reply six weeks later. This is three times more than its performance target. Set a specified time-limit as to how long refunds from HMRC should take. Where HMRC legislates that payments by taxpayers should be paid within a certain timeframe, it would be good to see HMRC observe the same standard by making refunds also by a specified timeframe. Businesses often complain of having to wait months on end for refunds from HMRC.

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Methods of business transactions With the average time spent on tax compliance and administration reduced by 8 hours over the past three years, likely driven by digitalisation, it is little surprise that three in four (75%) small businesses use paid accounting software to record their business transactions (Figure 5). For businesses operating for less than one year, only 44 per cent used paid accounting software. The average small business does not become profitable until two or three years of operations, and additional costs such as paid accounting software have to be weighed up against necessary business costs. Paid accounting software has increased in price in recent years, with one major software provider having imposed four price increases since HMRC’s Making Tax Digital (MTD) programme was introduced. Software costs are imposed on SMEs due to government policy, yet the Government has no oversight or caps on the cost increases. Many small businesses have been caught unawares by rising prices, as accounting software has transitioned from a one-off purchase to subscription-based pricing models.

With Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA, see section later in the report) becoming a mandatory programme in 2026 and 2027, more small businesses will fall into its scope. FSB previously called on HMRC to provide free MTD software options for small businesses who may struggle to afford accounting software in our report A Duty to Reform.4 HMRC currently lists ten MTD software providers, with 18 more in development, yet the HMRC website lists neither price comparisons nor advice for which providers are most suitable for small businesses or self-employed.5 FSB, as the representative voice for small businesses, has recognised the importance of solutions such as small business appropriate software, and has developed a Making Tax Digital app, powered by Rhino Software Ltd, to support small businesses with MTD for VAT and the upcoming transition with MTD for ITSA.

4 5

SB: A Duty to Reform: Making tax work for small businesses in a digital world, October 2021, https://www.

F fsb.org.uk/resource-report/a-duty-to-reform.html GOV.uk: Find software that works with MTD for ITSA https://www.gov.uk/guidance/find-software-thatscompatible-with-making-tax-digital-for-income-tax 19

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Figure 5: Small business choice of recording business transactions Source: 80% FSB 2024 tax survey 75% 70%

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Accounting Online software bank (paid for) statements

Paper receipts

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Paper Bespoke Handwritten Accounting bank accounting log software statements system (free)

Despite increased digitalisation, many small businesses still maintain more traditional methods of record keeping. A third of small businesses (35%) use paper invoices with the same proportion using paper receipts (35%), a quarter (25%) use paper bank statements, and one in 12 (8%) use handwritten logs.

An upcoming challenge for the Government is to strike the balance between promoting digitalisation, while ensuring that support remains in place for small businesses to choose how they wish to undertake transactions, as a meaningful portion still use paper-based systems. The Government has recently announced a consultation into B2B e-invoicing, looking at options to explore how e-invoicing could be adopted into the broader UK ecosystem.6 FSB recommends that e-invoicing be promoted through voluntary standards, allowing for small businesses to choose the best option for their business without being forced to mandate and bear the costs associated with additional regulation.

6

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GOV.uk, September 2024: “Chancellor unveils package to deliver on promises of new government” https://www.gov.uk/government/news/chancellor-unveils-package-to-deliver-on-promises-of-newgovernment

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Recommendations HMRC should: • Only promote e-invoicing through voluntary standards if Government intervention is necessary, not through mandating it. This will allow small businesses to choose their preferred method for invoicing (e.g. digital or paper) without being mandated to adopt it and bear the costs associated with additional regulation.

• Review the pricing of Making Tax Digital compliant software as part of the evaluation of the programme, and if needed introduce regulation to limit price increases. With small businesses mandated to comply with Making Tax Digital for Income Tax from 2026 and 2027, many small businesses will be signing up for MTD software for the first time, and given their small size, could be reliant on regulatory protections so that they are not subjected by software providers to excessive and unavoidable price increases.

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SMALL BUSINESSES AND HMRC Contacting HMRC HM Revenue and Customs (HMRC), responsible for administering the UK’s tax system, has long been a source of worry and administrative cost for small businesses. With over 5 million business taxpayers in the UK, HMRC has designed customer services to be increasingly digital, through online tax accounts, the HMRC app, or online guidance.

In 2022-23, HMRC received 38 million telephone calls from customers (both personal and business). However, only 20.5 million calls were answered - 54 per cent of all calls. In the Autumn Budget 2024, the Government announced it is investing in improving HMRC’s customer services, providing the resource needed to meet performance targets, including answering 85 per cent of phone calls where customers want to speak to an advisor. FSB’s survey found that the phone was small businesses’ most popular form of communication when contacting HMRC, with 68 per cent using it within the past two years.

Figure 6: In the past two years, what method have you used to contact HMRC? Source: FSB 2024 Tax Survey 80%

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Figure 7: How do you rate your experience of contacting HMRC? Source: FSB 2024 Tax Survey 70%

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Phone Despite being the most popular way of contacting HMRC, small businesses rated the phone unfavourably, with 61 per cent rating their HMRC experience as ‘poor’, and 23 per cent ‘good’ (figure 7). Nearly two-fifths (38%) stated it was ‘very poor’. The Administrative Burdens Advisory Board (ABAB) found similar results in its 2024 small business survey. ABAB found that over half (55%) of small businesses rate HMRC’s phone service as ‘poor’ and just 18 per cent as ‘good’ when asked about the ‘usefulness’ of the service.7 Phone service also had varying results based on regions; in Wales, 74 per cent rated their experience with the phone as ‘poor’.

HMRC personnel often appear lacking in knowledge. One client got totally confused and phoned HMRC three times to get three different answers to his problem.

FSB member, accountant, South-West 7

https://www.gov.uk/government/publications/administrative-burdens-advisory-board-tell-abab-report2023-to-2024/tell-abab-report-2023-to-2024#personal-and-business-tax-accounts 12.1.2 Usefulness of contact services – Telephony 23

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Digital services HMRC has increasingly shifted its focus onto digital services. In 2022-23 HMRC customers accessed online Personal and Business Tax Accounts and the HMRC app 199 million times.

This is a significant jump from 62 million in 2016-17.8 Despite the rise in new digital services, FSB’s research found that HMRC’s webchat was the least-used method; nearly two thirds (63%) of small businesses have not used this contact method. Customers are likely to have engaged with a digital assistant before going through to a real-time advisor. As a result, small businesses either drop off after interacting with the digital assistant, which provides generic computerised responses and cannot provide the expertise or tailored solutions which many small businesses need, or they are unable to be put through to a real-time advisor as this is dependent on staff availability. HMRC has planned for increased webchat usage to replace phone contact as part of its ‘digital-first’ service approach, with the Digital Transformation Roadmap to be published in Spring 2025.

Online forms, which allow for small businesses to click on question boxes to be provided with a detailed assessment or answer, was the joint second-most popular method of contact. Almost two fifths (38%) of small businesses rate their experience with online forms as ‘good’, and 34 per cent as ‘poor’. Online forms have the GOV.uk branding which is recognisable for small businesses.

Figure 8: Example GOV.uk online form

✓

Question one

8 National Audit Office, May 2024: HMRC customer service - NAO report https://www.nao.org.uk/wp-content/ uploads/2024/05/hmrc-customer-service.pdf 24

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Email and post Half of small businesses (51%) who used the post to contact HMRC rated the experience as ‘poor’. Email was only slightly less negative overall, with 47 per cent rating their experience as ‘poor’.

Small businesses’ experience with the post is mostly due to receiving correspondence from HMRC. Few taxpayers use the paper route to file tax returns, with 3 per cent using it in the 2022-2023 tax year, with paper tax returns due three months earlier than online tax returns.

HMRC services are increasingly removing postal forms: for example, as of late 2023, VAT registration is only available online. For small businesses who do use the post, one benefit they cite is that although it is slower, there is ‘no queue’.

Email communication from HMRC to taxpayers is limited and mostly promotional, such as links to webinars, reminders, and general updates. HMRC does not often communicate or reply to individual taxpayers by email and does not provide personal information, due to the risk of it not being a secure method of communication, liable to phishing and hacking.

I feel that the lack of any response these days from HMRC is having a major impact on my small business. The issue arose more than a year ago when I tried to register for VAT. Despite HMRC insisting on small businesses being engaged online via ‘Making Tax Digital’, they think it appropriate themselves to communicate via letter. When we applied for registration, there was a postal strike going on. This, plus the fact that HMRC sent out letters using only half of the address on more than one occasion, ensured that letters failed to arrive.

I collected VAT in good faith using a VAT number that had been issued but it then transpired it had been cancelled because HMRC had not received a reply to their letter.

A year has gone by with HMRC not responding to letters or phone calls, I am wondering what it takes to get issues resolved with them these days? They seem to assume that putting in place an online registration facility is sufficient to streamline the registration process, but their subsequent internal business verification and communication processes are not fit for purpose. Their practices seem extremely dated and overly slow. It must be having a detrimental effect on any smaller business with limited resources to deal with such a situation.

My frustration, after a total of 16 months of my accountant and me trying to get this matter resolved with HMRC, led me to write letters to my Member of Parliament and the Chancellor of the Exchequer at the time. I believe that it was only after the intervention of my local MP that I received two letters of apology from managers at HMRC for having caused the problems by their failure to attend to my VAT registration issues.

FSB member, Information and Technology sector, South East

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Third party Using a third party to contact HMRC was the second-most popular method of contact, jointly with online forms, with over three in five small businesses (63%) having used an intermediary to contact HMRC. Two-fifths (39%) rated this experience as ‘good’, with 26 per cent rating it as ‘poor’, making it the form of contact with the highest net favourability.

Using an agent can assist with more complicated cases, and they are able to contact HMRC through dedicated agent portals and hotlines, making communication with the tax authority easier for them and their clients.

Communication with HMRC and getting answers from them has been getting worse.

HMRC closed the Agent Dedicated Line in December and January during the height of the tax return submission for the 2023-24 tax year. I find they are pushing us towards digital as they do not want agents or taxpayers to phone them or write in.

One of my clients received a phone call from HMRC to inform them they had received the postal form to change their VAT status from sole trader to partnership, but this could take up to a year to process and suggested they do it online. I had tried doing that already for my client but got the message that it could only be done by post!

HMRC systems are not up to scratch and they should focus on fixing what they currently have before going further with digitalisation.

FSB member, accountant, South West

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HMRC experiences Despite offering a variety of contact methods, more than half (52%) of small businesses say that HMRC was not accessible to contact (Figure 9). As mentioned above, only 20.5 million of the 38 million customer calls to HMRC were answered in 2022-23. Small businesses have spoken about the length of time they may spend waiting on the phone; the National Audit Office found that those who did manage to get through to an adviser had waited on average 23 minutes in 2023-2024, up from five minutes in 2018-19.9 Figure 9: Experiences with HMRC Source: FSB Tax Survey 70%

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HMRC was accessible to contact

HMRC was able to provide me with an answer or information I required

HMRC was timely\with its response

Waiting for HMRC to resolve my issue impacted my business

Agree

9

I felt the need HMRC Dealing with to go to a communicated HMRC has third party to to me what was resulted in get a required from increased response/ my business personal stress action after waiting for HMRC to respond

Disagree

Taxpayers let down by poor HMRC customer service - NAO press release 27

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Nearly half of small businesses (44%) do not think HMRC was timely with its response, compared to 21 per cent who agree.

A third (34%) of small businesses say that waiting for HMRC to resolve their issue impacted their business. Small businesses are expected to respond to HMRC within set deadlines, and those who exceed deadlines face penalties. However, enforcing deadlines is a onesided approach, as HMRC only provides estimated timeframes for when it may respond, which are overly optimistic when in fact customers often experience delays in response times. Shorter timescales should be enforced to ensure that HMRC responds in a timely manner.

As a result, small businesses have felt they are not valued customers of HMRC, and 38 per cent have felt the need to go to a third party, such as an accountant, adviser, or agent to prompt a response from the tax authority. This is costly to many small businesses as the services of accountants, whilst valuable, could be avoided in this instance if HMRC were able to fulfil its estimated timeframes for responding.

We are a small business and for many years we operated as a sole trader and we are now changing to a limited company. We wanted to transfer our current VAT number over to our new limited company and were informed by HMRC that this will take a year.

HMRC proposed to us that a quicker solution would be to deregister our sole trader VAT and re-register under a new VAT for our limited company.

But we have all of our business stationery, letterheads and other items that have been paid for and arranged with the old VAT number. This proposed work-around would cost us more money and time to repurchase new items with the new VAT number.

FSB member, Construction, East Midlands Small businesses are faced with tight margins, and given the current economic climate, it does not seem like this will change any time soon. Additional and unnecessary costs, such as replacing items with a new VAT number, as was suggested by HMRC in the case study above, are something that many small businesses will struggle to afford, and in other cases would come at the cost of spending on more productive activity. However, waiting a year for the transfer of a VAT number is not practical either.

Over a third of small businesses (35%) say they were able to receive the information and advice they had sought from HMRC, compared to 29 per cent who say this was not the case. A third (33%) of small businesses agreed that HMRC communicated what was required from their business, whereas 28 per cent disagreed.

Alarmingly, 60 per cent of small businesses have found dealing with HMRC has resulted in increased personal stress, which equates to around 3.4 million small businesses across the UK. By region, around three quarters of small businesses in Wales (74%) reported this figure, with high results also recorded in North West of England (66%) and Scotland (62%).

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This reinforces the need for proper training programmes for tax compliance officers and investigators within HMRC, who are often the largest initiators of stress.

We were the subject of a five-year investigation into our business and private tax affairs which ultimately found no tax to be paid and in fact we received a refund of £600 and an apology from the head of HMRC. It took us more than 3,000 hours over the five years to counter the outrageous accusations of HMRC when they undertook what our MP described as a "heavyhanded, unfair and unreasonable HMRC inquiry into my constituents' business", yet we have not even had the cost of our time refunded, calculated by our accountants at £279,000 + VAT. FSB member, Wholesale and Retail, Manchester In the Autumn Budget 2024, the Government announced a commitment to £262 million for HMRC over five years to fund an additional 1,800 debt management staff, in order to raise £2 billion per year in additional revenue by 2029-30. A system where investigators’ performance incentives are stacked towards maximising the tax revenue that can be recovered is highly unlikely to support fair investigations, and we therefore would like to see a portion of this money spent improving HMRC’s customer service and treatment of small businesses. Upstream compliance cannot be achieved without addressing and improving customer services.

During lockdown, we felt we had good support from HMRC and they were understanding of businesses’ circumstances.

In early 2023, this all changed. HMRC called up demanding £20,000 in payments to be made that week in VAT. We were still dealing with the aftermath of the pandemic and a cost-of-living crisis which had hit hospitality businesses very hard.

HMRC had no consideration that paying that amount means the business would go under. There was no lenient approach or payment plan from HMRC, just demands for the immediate cost to be repaid.

FSB member, hospitality, Norwich.

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Recommendations HMRC should: • Impose a duty of candour on HMRC’s tax compliance officers. This will require officers to be open and honest about mistakes, and to inform a small business owner under investigation of their rights within the tax investigation process at the outset as well as the full consequences of any concessions made.

Small businesses are often unaware they can utilise the service of professional accountancy services and specialists to help guide them through the HMRC process, and even deal with HMRC on their behalf. A duty of candour will help prevent poor treatment of taxpayers by public officials and help build trust between tax collector and taxpayer.

• Review and design tax investigator performance incentives so that incentives are focused on a fair investigation and not disproportionately weighted towards revenue maximisation at the cost of a fair process. Tax investigators should adhere to a code of conduct and that due process is followed as a priority. HMRC should base performance incentives on fairness in processes, rather than on greatest revenue recovered.

• Set a time limit on the length of HMRC tax investigations, while investigations that go over the time limit period will need strong justification for doing so.

Currently, full enquiries on average can take up to 18 months to finish; however, this is not strictly enforced, and some small businesses have undergone tax investigations that have taken years to be resolved, which comes at a cost of great financial and emotional stress, but also limits HMRC resources. Once an appropriate time limit has been set, FSB would call for this to be enforced by the tax tribunal, unless HMRC can provide strong justification for the reason why a tax investigation has taken longer than usual.

• Improve the accessibility of HMRC services. HMRC’s services and communications channels must be tested for accessibility, to ensure they work equally well for taxpayers who are neurodivergent, and providing alternative channels of communication where needed.

The National Audit Office or the Adjudicator’s office should: • Undertake audits of HMRC investigations to check that investigators are following due process. This would encourage a higher standard for tax investigators to maintain, so that small businesses experience a fair investigation.

Many small businesses do not have the time, resources or money to review a HMRC tax investigation or take HMRC through to a tribunal to dispute a tax investigation.

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Making Tax Digital Making Tax Digital (MTD) is HMRC’s flagship digital transformation programme, and is currently in the phase of moving Income Tax Self Assessment (ITSA) onto a modern tax management platform. Making Tax Digital for Income Tax Self-Assessment is due to commence in April 2026 for small businesses with a turnover greater than £50,000, and from April 2027 for small businesses with a turnover between £30,000 and £50,000. The Government recently announced it intends to include sole traders and landlords with qualifying income over £20,000 joining from April 2028. Three in five small businesses (63%) with turnover above £50,000 already use MTD-compatible software.

For those who do not currently use MTD-compatible software who have a turnover larger than £50,000, 9 per cent plan to move over to it over the next year until April 2026, and a further 2 per cent plan to move over to the software between April 2026 and April 2027 in preparation for the second tier of the £30,000 to £50,000 cohort.

However, over a quarter of small businesses (27%) with turnover above £50,000 do not know when they plan to adopt MTD-compatible software. This highlights the concern that the MTD programme has not seized the opportunity to be more recognisable and promote to small businesses the genuine benefits which accrue from digitalisation. The Administrative Burdens Advisory Board’s 2024 survey found that 23 per cent of businesses were not aware of the next phase of MTD for ITSA, and 21 per cent did not know about it in its entirety.10 HMRC will need to continue to support onboarding small businesses to ensure they feel prepared for the upcoming changes. Figure 10 shows that for small businesses with over £50,000 turnover, net 55 per cent are feeling prepared. This decreases to 48 per cent for £30,000-£50,000 turnover, and to 39 per cent for the sub-£30,000 cohort. Awareness of the programme will be crucial to ensuring its success; when asked about the benefits that the MTD for ITSA programme will deliver, 65 per cent of respondents say ‘no benefits’.11

10 G OV.uk, September 2024: “Tell ABAB report 2023 to 2024” https://www.gov.uk/government/publications/ administrative-burdens-advisory-board-tell-abab-report-2023-to-2024/tell-abab-report-2023-to2024#making-tax-digital-mtd-forincome-tax-self-assessment-itsa 11 Ibid.

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Figure 10: Small businesses’ preparedness levels for MTD for ITSA, by turnover Source: FSB 2024 Tax Survey 100% 13% 90%

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TAX RELIEFS This section focuses on the tax reliefs important to small businesses, and their economic effect on driving business behaviours. Tax reliefs, if designed effectively and targeted, are an important lever for the Government to deliver national economic policies, including increasing business investment. Small businesses tend to have a broad exposure to tax, so are often entitled to a range of tax reliefs.

Tax reliefs are defined by HMRC as either structural, i.e. they are regarded as an integral part of the tax system, or as non-structural, i.e. they are designed to help or encourage particular types of taxpayers, activities or products for economic or social objectives (for example R&D tax credits). In A Duty to Reform, FSB identified that the average small business owner is only aware of five potential tax reliefs they may be eligible for, and therefore are not making full use of the reliefs they are entitled to.

Figure 11: Tax reliefs claimed by small businesses within the last two years Source: FSB 2024 Tax Survey 45% 40% 35%

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Small Employment Dividend Business allowance allowance Rate Relief (England Only)

Pensions tax relief

Small Annual Employer’s Investment Relief Allowance

R&D tax credits

First year allowance

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Small Business Rate Relief For small businesses, over two in five (41%) have claimed Small Business Rate Relief (SBRR) within the last two years, making it the most widely-used tax relief. Under SBRR, eligible small businesses can lower or eliminate their business rates bill. FSB’s 2024 report The Future of the High Street found that almost half (49%) of small businesses say that SBRR is essential, and that their business would not survive without it.12 SBBR is significantly higher amongst retail and hospitality businesses, with three in five businesses claiming it (61%).

However, these sectors are more likely to operate out of ‘brick and mortar’ premises. The SBRR is considered the most valuable relief by small businesses; of those who selected it as a relief claimed in the last two years, 95 per cent say that it was valuable.

FSB has previously called on the UK Government to increase the threshold for full SBRR in England from £12,000 to £25,000 of ratable value.

The retail rate relief on business rates gives my business a £2,000 a month relief on my overhead; however, this will decrease with the retail rate reduction taking place in April 2025. The relief makes a huge difference and gives us the opportunity to look at investing in equipment. At present, the relief allows for me to take on new staff and pay the staff we currently have. Now, recruiting is impossible and the staff we have are often looking for pay rises. It is a squeeze in our market to find a qualified technician but the relief gives us the opportunities to invest in advertising for jobs.

FSB member, automotive industry, East of England

12 F SB, August 2024: The Future of the High Street, https://www.fsb.org.uk/resource-report/the-future-of-thehigh-street.html 34

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Figure 12: Tax reliefs claimed by small businesses within the last two years by sector Source: FSB Tax Survey 70%

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Small Employment Dividend Pensions tax Small Annual Business Allowance allowance relief Employer’s Investment Rate Relief Relief Allowance (England Only)

R&D tax credits

First year allowance

Very pManufacturing

Construction

Wholesale & retail

Accommodation and food service activities

Information and communication

Professional, scientific and technial activities

Business rates is a devolved area and operates differently in England, Northern Ireland, Scotland and Wales. This report’s findings focus on England-only. FSB’s national teams work to address issues and provide responses and solutions to devolved governments’ policies in their own respective nations.

Employment Allowance The second-most widely claimed form of relief among small businesses is the Employment Allowance, at 34 per cent. It is, however, likely that some small businesses which are currently claiming the employment allowance did not select this option as they may be unaware that they are claiming it, so this figure could be an underestimate.

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In the 2024 Autumn Budget, the Chancellor announced that the value of the Employment Allowance would be increased from £5,000 to £10,500 as of April 2025, which will mean that its value equates to the employer NICs for four full-time employees on the National Living Wage. Prior to the Budget, FSB had called on the Chancellor to raise the Employment Allowance, to mitigate the rising costs of employment. The Chancellor also announced that the Employment Allowance would become a structural relief, meaning that all employers will be able to claim it in the future. However, given the rising costs of employment, and the importance of the Employment Allowance to those who do claim it, it is important that we continue to raise awareness among small employers about how to claim it.

Am I eligible for the employment allowance?

• You are registered as an employer • Sole trader, limited company or partnership that has employees •A limited company that employs only directors, where two or more directors earn more than the secondary threshold for Class 1 National Insurance contributions •E mployers’ Class 1 National Insurance liabilities were less than £100,000 in the previous tax year. The £100,000 restriction is removed from April 2025 onwards.

How does it work?

The allowance applies to your business, not to individual employees. So, for example, if your 2025/26 NICs bill is £11,000 in total for the tax year, you’ll only need to pay the £500 excess.

If you have more than one payroll, you can only claim against one of the payrolls.

How do I claim my employment allowance?

Small businesses can claim at any point during the tax year as part of your Real Time Information (RTI) submission to HMRC. You will then pay less employer NICs each month until the limit has been reached (£10,500 in 2025/26). You can start using your allowance as soon as you submit the claim.

Claiming Employment Allowance is not an automatic process: you need to tell HMRC that you qualify and want to claim. An employment payment summary (EPS) is sent to HMRC to apply any reductions on what you will owe from your Full Payment Submission, including the Employment Allowance.

You need to claim the Employment Allowance every tax year to ensure you are still eligible. Relief cannot be carried over between tax years.

FSB Payroll and Tax Experts

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Employment Allowance usage is highest in the manufacturing sector, at 42 per cent, and in the accommodation and food services sector, at 37 per cent. One factor for why these sectors may be higher is that they traditionally have a higher staff count, which results in an increase in the employer’s National Insurance contributions. However, across the sectors, there is only a 9 per cent difference between the highest and lowest sectors that claim the Employment Allowance.

Dividend Allowance A close third, with 32 per cent of small business claiming this tax relief, is the Dividend Allowance Income from dividends is taxed at 8.75% (basic rate), 33.75% (higher rate), and 39.35% (additional rate), while the Dividend Allowance exempts the first £500 of dividend income from tax, an amount that has fallen from £1,000 in 2023-24 and £2,000 between 2018-19 to 2023-24. Small business owners who receive dividends of more than £500 in a tax year will have to pay tax on that income, unless their total income falls below the normal tax-free personal allowance.

The professional, scientific and technical activities sector is the major sector with the highest percentage of limited companies, which as a result means that this sector has the highest percentage of small businesses claiming the Dividend Allowance at 42 per cent, 10 percentage points higher than the average for all businesses.

Changes to dividend taxes have made it less appealing for business owners to rely on dividends, prompting a rethink in how they pay themselves. However, 81 per cent of small businesses who claim it say the Dividend Allowance was valuable (figure 13).

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Figure 13: How valuable is your tax relief to your business?

Source: FSB 2024 Tax Survey 100%

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Employment Small Annual Allowance Employer’s Investment Relief Allowance

R&D tax credits

Very valuable

First year allowance

Small Business Rate Relief

Dividend allowance

Pensions tax relief

Somewhat valuable

Pension tax relief One in five small businesses (19%) have claimed pension tax relief within the last two years, and of those who claimed, 91 per cent say it was a valuable tax relief to their business. The pension tax relief available to a small business can depend on the structure of the business, as outlined below; • For limited businesses, where the small business owner is a director, pension tax relief can take the form of employer pension contributions deducted as a legitimate business expense and offset against taxable profit to reduce the Corporation Tax bill.

A fifth (20%) of private company limited by shares have claimed pension tax relief, and of those who do, 94 per cent say it was valuable to their business.

• Pension tax relief usage is also high amongst limited liability partnership (LLP) small businesses, where 29 per cent have claimed the relief. Pension contributions are treated as personal contributions, therefore allowing partners of these small businesses to receive a 25 per cent bonus on top of contributions, as well as relief on the contributions, up to 100 per cent of earnings.

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The UK is an aging nation: in 2022, 19 per cent of the population were over 65 years old, and this is forecast to increase to 27 per cent of the population by 2072. Pension tax relief encourages small business owners to be able to retire as self-sufficiently as possible without creating additional demands on welfare finances. Reforms of pension tax relief must not leave behind small businesses and self-employed people, and must ensure that small business owners, many of whom forego a pension to run their business, are supported to make pension contributions, without reducing their business operations to find savings to fund their retirement.

Small Employers’ Relief One in eight (12%) small businesses have claimed Small Employers’ Relief, allowing the employer to reclaim some, if not all, of the statutory parental payments paid to employees.

Small Employers’ Relief is a scheme that allows qualifying small businesses to claim 100 per cent plus an additional 3 per cent of their employees’ statutory maternity, paternity, adoption, parental bereavement, and shared parental pay. Without SER, employers can still claim up to 92 per cent of the amount paid. The current 103 per cent rate has been set since April 2011, and was decreased from the previous 104.5 per cent rate in place since April 2004. However, in early 2025, HMRC notified software developers of plans to increase the rate to 108.5 per cent in April 2025.

The current eligibility criteria for Small Employers’ Relief require a small business to have a total Class 1 National Insurance bill of less than £45,000. This rate of £45,000 has been set since April 2004, unchanged for nearly two decades. Had it risen in line with inflation, it would stand at nearly £80,000 (as of December 2024).

The Government announced in the Autumn Budget 2024 that Class 1 Employer NICs would increase from 13.8 per cent to 15 per cent on salaries above £5,000 (previously £9,100) as of April 2025. This will significantly erode the number of small businesses who will have previously qualified for Small Employers’ Relief.

Nearly nine in ten of those who claim it (88%) say that Small Employers’ Relief was is valuable; this is, however, higher for information and communication (100%), accommodation and food services (96%), and retail (93%).

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Recommendation: FSB recommends two options to increase the Small Employer’s Relief eligibility threshold of Class 1 National Insurance contributions from its current rate of £45,000.

Option 1: • Retain the threshold for Small Employers Relief at £45,000 or less Class 1 NICs, but with the Employment Allowance reduction applied.

• Currently the Class 1 NICs threshold of £45,000 is before any deductions such as the Employment Allowance are applied.

• By including the Employment Allowance into the threshold of £45,000, a small business can have a NICs bill of up to £55,500, apply the Employment Allowance to bring their bill down to £45,000, and claim Small Employers’ Relief.

• As illustrated in the scenario below, the example small business has its Class 1 NICs bill increase from £32,349 to £51,667.

Option 2: • Increase the threshold for Small Employers’ Relief from £45,000 to £100,000.

This would bring it in line with the previous Employment Allowance threshold.

• In April 2020, the previous Government, identified a NICs threshold of £100,000 for the Employment Allowance as one that would include small employers.

• The £45,000 threshold rate was set in 2004; had it risen in line with inflation, it would have reached nearly £80,000 by December 2024. This would allow the policy’s headroom to be maintained for a number of years as small businesses will continue to face, at minimum, inflation-indexed increases in labour costs (e.g. rises in the National Living Wage).

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Manufacturing small business (Business 1) with 20 employees on National Living Wage (NLW). Employee A is pregnant and will take 39 weeks of statutory maternity leave.

Employee A earns NLW. She starts maternity leave and will take it for 39 weeks. She works full time at 35 hours a week and will be eligible for Statutory Maternity Pay (SMP).

Statutory Maternity Pay (SMP) is usually 90% of average weekly earnings first six weeks and for the remaining 33 weeks it is paid at £184.03, or 90% of average weekly earnings (whichever is lower).

Employee A NLW salary

£11.44 per hour

Average weekly earnings

£400.40

90% of Average weekly earnings

£360.36

Total Maternity Pay

6 x £360.36 + 33 x £184.03 = £8,235

Employee A will get £360.36 of statutory maternity pay each week for the first 6 weeks of her maternity leave.

As £360.36 is more than £184.03, Employee A will then get £184.03 of statutory maternity pay each week for the next 33 weeks of her maternity leave.

Business 1 has a total of 20 employees, including Employee A, who are all working full time on the NLW. These calculations are based on NLW at £11.44 and National Insurance contributions at a rate of 13.8% with a threshold of £9,100 as of December 2024.

Employee A full time NLW salary

£11.44 per hour (£20,820.80 annually)

Employee National Insurance contributions

(£20,820.80 - £9,100) x 13.8% = £1,617.50

Total NICs (all 20 employees)

(£1,617.50 x 20) = £32,349

As Business 1’s NICs are below the £45,000 eligibility threshold, it is eligible for Small Employers’ Relief and can claim 103% of the statutory maternity pay of Employee A.

Smaller Employer’s relief (103%)

(£8,235 x 103%) = £8,482

Business 1 received the maternity pay back (£8,235) as well as an additional payment of £247.

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From April 2025, changes announced in the 2024 Autumn Budget are now in effect. These changes include an increase in the NLW to £12.21 an hour, increase in NIC rates to 15%, and a decrease in the threshold to £5,000, while the standard rate of maternity pay increased to £187.18.

If Employee A takes her maternity leave from April 2025;

Employee A full time NLW salary

£12.21 per hour

Average weekly earnings

£427.35

90% of average weekly earnings

£384.62

Total Maternity Pay

6 x £384.62+ 33 x £187.18 = £8,485

Employee A will receive £384.62 for the first 6 weeks, and £187.18 for the remaining 33 weeks. Her total maternity pay over 39 weeks will be £8,485.

Business 1 has a total of 20 employees, who are all on NLW. This brings business 1’s total NICs, as of April 2025 to £51,667.

Employee A full time NLW salary

£12.21 per hour (£22,222.20 annually)

All Employee National Insurance contributions

(£22,222.20 - £5,000) x 15% = £2,583.33

Total NICs (all 20 employees)

(£2,583.33 x 20) = £51,667

Business 1 is now above the £45,000 eligibility threshold, and is only eligible for statutory relief of 92% on the Statutory Maternity Pay. Statutory relief (92%)

(£8,485 x 92%) = £7,806

Business 1 had £7,806 of Employee A’s maternity pay (£8,485) covered, making a loss of £679.

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How tax reliefs grow the economy The broad objective of tax reliefs for small businesses is to encourage growth and target business investment. Nearly three-quarters (73%) of small businesses, when asked what they intend to do with the additional savings made on tax reliefs, say they would use these savings for investment purposes. The remaining quarter would use the savings to manage business cashflow, contribute to a pension or retirement savings, and expand business through export and imports.

When breaking down what small businesses intend to use investment for, 43 per cent plan to invest in staff training and upskilling, and 41 per cent would invest in hiring new apprentices and staff. Investment in training and skills in the UK has declined over the past two decades. Over the years, multiple reforms to different elements of the skills system have resulted in ‘chopping and changing’, making it challenging for small businesses to navigate the system. Tax reliefs offer the opportunity to expand employer-provided training for small business employees with a specific focus on upskilling.

Over a third of small businesses (35%) would invest in new technology, while nearly as many (32%) would invest in assets or capital (32%) with their tax relief investment savings. FSB’s 2024 report The Tech Tonic found that 30 per cent of small businesses identify financial costs as a top barrier to improving their products, and 28 per cent identify that the cost of overall innovation is too high. This is even more pronounced amongst disabled business owners (34%) and female-led businesses (33%).13 Tax reliefs are a crucial lever that provide financial incentives for small businesses to invest and innovate.

One fifth (21%) of small businesses say their tax relief savings would be used to invest in green technology and/or to decarbonise their business. Investing in green technology and decarbonisation has a high upfront cost for small businesses, and with cash flow constraints, tax reliefs are an important incentive to encourage small businesses to make the financial decision to reduce their carbon footprint and become more energy-efficient.

Previous FSB research found that nearly a quarter (22%) of small businesses pointed to a lack of capital (savings) as a reason to why they are unable to invest in greener technology.14

13 FSB, The Tech Tonic, August 2023, https://www.fsb.org.uk/resource-report/the-tech-tonic.html 14 FSB, Accelerating Progress, 2021 https://www.fsb.org.uk/resource-report/accelerating-progress.html 43

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Recommendations HM Treasury should: • Commit to making National Insurance contributions relief for hiring veterans a permanent measure. At the 2024 Autumn Budget, the Government announced it would extend the employer National Insurance contributions relief for employers hiring qualifying veterans for a further year, until 5 April 2026. Alongside X-Forces, FSB was the original co-designer of this policy idea, which we continue to support strongly. If agreed, FSB would run an awareness-raising campaign to ensure that this important change was promoted to small employers in all local communities.

This scheme should be made a permanent measure, allowing small businesses to continue to pay no employer NICs up to annual earnings of the Veterans Upper Secondary Threshold of £50,270 for the first year of a veteran's employment in a civilian role.

• Increase the eligibility threshold for Small Employers’ Relief. FSB proposes two options for the Government to consider: – Option 1: Retain the threshold for Small Employers Relief at £45,000 or less Class 1 NICs, but with the Employment Allowance reduction applied.

This means a small business can have a National Insurance bill of up to £55,500, apply the Employment Allowance to bring their bill down to £45,000, and claim the Small Employers' Relief.

– O ption 2: Increase the threshold for Small Employers' Relief from £45,000 to £100,000. This would be in line with the previous Employment Allowance threshold, where businesses with National Insurance contributions of up to £100,000 were classed as small businesses.

• Maintain the Business Asset Disposal Relief (BADR) rate at 14 per cent going forward. The relief provides hard-working small businesses incentives to continue to invest and expand their business; the additional capital saved as a result from the relief can be used for entrepreneurial decisions such as selling a business or reinvesting, or for those who have worked many years, often without pension savings, to be able to fund their retirement. The amount of tax paid by business owners relying on BADR has already increased by 40% in 2025. Over four-fifths (83%) of small businesses plan to use BADR in the future if eligible, with almost all (94%) of those in the accommodation and food services industry planning to do so.

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All small employers should: • Check that they are correctly claiming the Employment Allowance in order to gain a £10,500 reduction on their employer National Insurance contributions in 2025/26. Small businesses can claim at any point during the tax year as part of their Real Time Information (RTI) submission to HMRC. HMRC should: • Increase the visibility of the section labelled ‘tax reliefs’ on self-assessment tax returns, and for online forms, include a pop-up or reminder to encourage taxpayers to check if they need to fill in this section if they have not done so.

For example, 48 per cent of self-employed people are saving into a pension, but only 19 per cent use pension tax relief. If a self-employed person earns £50,000 or more, paying income tax at 40 per cent, they are eligible to claim an extra 20 per cent tax relief on their self-employed pension through their Self-Assessment Tax Return, in the section labelled ‘tax reliefs’. Government must increase awareness of this benefit, and of similar available reliefs, in order to improve uptake levels.

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METHODOLOGY This report is based on the views of FSB members as well as the wider self-employed population across the UK. The survey was nationwide in its reach and participants were invited to complete the survey via email and social media channels. The survey was administered by the research agency Verve and was in the field from 31 July 2024 to 14 August 2024. The survey questionnaire was completed by a total of 1,436. The survey findings are all weighted according to FSB membership weighting (to reflect the demographic balance of FSB members throughout the UK).

All percentages derived from the survey are rounded to the nearest whole number, which is why some percentages presented in the figures do not sum to 100 per cent. The focus groups took place via Zoom and purposefully drew from a variety of regions, sectors, and population demographics.

FSB undertook a mixed research approach consisting of a quantitative online survey, focus groups which took place in October 2024 on Zoom. Interviews took place between October 2024 and January 2025.

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fsb.org.uk @fsb-uk @fsb_policy FSB Westminster (Federation of Small Businesses) If you require this document in an alternative format please email: accessability@fsb.org.uk © Federation of Small Businesses 2025

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior permission of FSB. While every effort has been made to ensure the accuracy of the facts and data contained in this publication, no responsibility can be accepted

by FSB for errors or omissions or their consequences. Articles that appear in the report are written in general terms only.

They are not intended to be a comprehensive statement of the issues raised and should not be relied upon for any specific purposes. Readers should seek appropriate professional advice regarding the application to their specific circumstances of the issues raised in any article.

This report can be downloaded from FSB’s website at www.fsb.org.uk