This chapter concentrates on how tax affects the self-employed in the UK with guidance about:
- Registering as self-employed
- Tax returns and deadlines for the self-employed
- Allowable tax-deductible and non-deductible business-related expenses for the self-employed
- Tax-deductible expenses when working from home
- Simplified business expenses
- The self-employed and capital allowances
- Keeping business records – accounting methods and which financial records should be kept
- Income tax payments – deadlines and payments on account
- Self-Employed business losses
- National Insurance contributions for the self-employed
- The self-employed and VAT
A tax guide for the self-employed
According to the latest ONS (Office of National Statistics) figures for April 2017, self-employed people make up 15% of all people in work in the UK. There are many advantages of being self-employed such as being your own boss and making your own decisions about how and when to work but there are also many more responsibilities. Ultimately you’re responsible for the success of your business venture and also you need to know which taxes you should pay.
In this guide we turn our attention to self-employed people or sole traders and what you need to know about your tax liabilities with advice about how/when to file a tax return, tax-deductible business-related expenses as well as solutions if your business records a loss. Finally, we consider indirect taxes – National Insurance and VAT and how they affect the self-employed.
Are you self-employed? – Registering with HMRC
It might seem a stupid question to ask yourself whether you’re self-employed or not but if you have a main job as a salaried employee, things aren’t so straightforward and this has repercussions for your status as a sole trader and as a taxpayer.
To find out whether you’re self-employed or not, go to the HMRC website and complete the HMRC Employment Status Indicator. This is completely anonymous and it won’t ask you for your name.
Once you’ve confirmed your status as self-employed, you need to register: either online or by calling the HMRC Newly Self-Employed hotline on: 0300 200 3504. This must be done no later than October 5th after the end of the tax year when you started trading and for which you need to file a tax return.
Tax returns for the self-employed
On their website HMRC offers guides, videos and live webinars to help taxpayers complete their Self-Assessment tax return or you could use an accountant to help you with the finances in the initial stages of your business leaving you time to concentrate on running the business itself.
As well as your main tax return, you’ll also have to fill in a supplementary SA103 component, which will be sent to you automatically if you’re registered with HMRC as self-employed.
Deadlines for filing tax returns
You should receive a letter in April from the Tax Office explaining how and when your tax return should be submitted. Paper tax returns must arrive no later than 31st October whilst online returns must be sent by 31st January. There are penalties for being late in submitting your tax return and these increase the later you are.
How do you complete a tax return?
Quite simply, you detail all of your business-related expenses and allowances to calculate how many expenses are tax-deductible. Therefore, your taxable profits are your yearly takings after you’ve subtracted your allowable business expenses, your losses and your annual investment or capital allowance (if applicable).
The problem which many self-employed people face is that they aren’t sure which business-related expenses are tax-deductible so let’s look at this in more detail.
You should check with HMRC that you are self-employed and register with the tax authorities by October 5th.
HMRC offers guidance on filling in tax returns or you could consult an accountant.
The deadlines for submitting a tax return are 31st October (by paper) or 31st January (online) and there are penalties for delays.
To work out out your taxable income, you subtract your business-related expenses and/or allowances from your yearly earnings.
Allowable tax expenses for the self-employed
There are a number of business-related expenses which are tax-deductible if you’re self-employed and these include:
- Expenses for your business premises (e.g. heating, lighting,etc.)
- Things you buy to sell on (e.g. raw materials, stock, etc.)
- Office costs (e.g. stationery)
- Travel costs (e.g. running costs for a vehicle)
- Clothing (e.g. protective gear but not everyday clothes you wear to work)
- Financial products (e.g. business insurance, accountants’ fees, etc.)
- Business advertising/marketing (e.g. subscriptions to professional organisations, website costs)
Although you can claim against a vehicle used exclusively for your business, you can only subtract a proportion of its running costs if it’s also used privately. To avoid confusion, it’s a good idea to keep a log of your business mileage and all bills so you can make an accurate estimate for income tax purposes.
Non-deductible tax expenses for the self-employed
Although you can claim for the salaries and benefits for any employees you have, you can’t claim for your own National Insurance, life (or other private) insurance, pension contributions, etc. Commuting costs, the cost of buying a vehicle or your meals (unless they’re reasonable amounts for overnight business trips) can’t be included in your business-related expenses either.
The initial cost of your business premises and the cost of extensions aren’t tax-deductible. However, you may qualify for an annual investment allowance or capital allowance.
The initial cost of your business premises and the cost of extensions aren’t tax-deductible either though you may qualify for an annual investment allowance or capital allowance.
Go to the government website for a more detailed analysis of what business-related expenses are tax-deductible to avoid making any mistakes.
Questions on self-employment tax
Self-employed individuals in the UK are liable to pay income tax on their profits, but not their total income. Self-employed professionals are eligible to deduct a variety of expenses from their operations, depending on their activities related to their business. The amount of income tax that is paid on the profits of a self-employed individual is the same as if they were employed.
HMRC recommend that self-employed individuals register as such as soon as they become self-employed for income tax purposes. However, it is not technically mandatory, from an accounting perspective, to register as self-employed until the 5th of October in the second year of your business’s operation. A tax year runs from 6 April to 5 April of the following year.
The personal allowance for the self-employed was increased in for the 2018/20 tax year to £11,850. The personal allowance is, in effect, the amount that a self-employed individual can earn before becoming liable to pay any income tax. For income above this amount, the self-employed are subject to income tax based on the official tax brackets and respective rates.
Tax-deductible expenses when working from home
If your business doesn’t need separate business premises and you work from home, you can claim a proportion of the costs as tax-deductible. You would need to calculate how much of your home is used to run your business. Depending on the nature of your job, you could calculate this based on the floor space used for your business, by the number of rooms needed for your job or the time a room is used for your business (for rooms which are also used privately).
To simplify matters, HMRC also have flat rates for such cases. Let’s look at this in more detail. Under which circumstances can you used flat-rate business expenses?
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What are simplified business expenses?
You might be involved in a business where your income doesn’t allow you to run your own business vehicle or rent separate business premises. In this situation, your claim for business-related expenses can be simplified by using flat rates for working from home, using your vehicle for both business and privately and also when you live on your business premises. These flat rates simplify your claim when filing a tax return and are available from HMRC.
How many people are self-employed in the UK?
According to the ONS (April 2017), the number of self-employed people in the UK rose in the last quarter by 114,000 and now stands at 4.78 million people.
Which self-employment tax SA103 supplement should I complete?
You should use the short tax supplement if you have an annual turnover of up to £83,000 and if your tax return has no complications such as a change in your accounting year.
Can I claim the cost of buying a car on my business-related expenses?
The rules for buying a vehicle are quite complex. They come under the rules of capital expenditure regime and so only a percentage can be taken into account unless they have low carbon emissions or they’re exclusively used for the business.
Do I have to pay tax on items I sell on websites?
HMRC isn’t interested in part-time hobbyists who sell some items on websites but people who regularly sell things to make a profit. Recent rules have made it clear that ordinary taxpayers who make up to £1,000 a year on sharing economy websites don’t have to declare this income and aren’t classified as self-employed.
The self-employed and capital allowances
In order to work well and efficiently, you may need to buy some business equipment. Depending on the nature of your business, this could be electronic equipment such as computers or printers or it could be machinery or tools. All of these are classified as capital assets and you’ll qualify for tax relief on them.
For the 2017-18 tax year, you’re entitled to spend up to £200,000 per year as an annual investment allowance and the purchase price of these items can be offset against your tax bill, effectively lowering the amount you’ll be taxed on. Therefore, when you complete your tax return, you should deduct the full cost of any business-related equipment.
For the 2017-18 tax year, you’re entitled to spend up to £200,000 per year as an annual investment allowance.
When filing your tax return, you should be aware of which business-related expenses are tax-deductible and which aren’t.
If you’re self-employed and work from home, you can claim a proportion of your expenses for your residence.
Simplified flat-rate deductions make it easier to calculate business-related expenses when working from home or using your own vehicle for business as well.
The purchase of business equipment can be deducted from your taxable income – with an annual limit of £200,000 for this investment allowance.
The self-employed and keeping business records
If you’re self-employed, it’s vital that you keep well-organised business records. You should get into the habit of filing and keeping track of all your business-related expenditure and takings. Not only will this simplify matters for you when it comes to completing your tax return but HMRC have the power to inspect your business records at any time.
Records should be kept for at least 5 years from 31st January following the relevant tax year in case the Tax Office has reason to query your figures or you’re chosen for a random inspection. If your records are unavailable or otherwise lost, you could face a fine of £3,000.
One question self-employed people often have is that they aren’t sure which business records should be kept. This depends on which accounting methods you use so let’s consider the different methods and then which business records should be kept.
Accounting methods for the self-employed
There are 2 methods of keeping business records: traditional accounting and cash basis accounting. With traditional accounting, you keep a record of your income and expenses by the date you were invoiced or billed (and not when invoices and bills were actually paid.)
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On the other hand, with cash basis accounting you record your income and expenses on the dates you actually received the money or paid the bill. The main advantage of this accounting method is that you won’t have to pay tax on income which you’ve billed but haven’t received yet. This is especially useful when your income remains unpaid near the end of your accounting period or tax year. However, this method can only be used for turnover of under £150,000.
Which business records should be kept?
A general rule of thumb when it comes to keeping business records is that if you’re in doubt, keep it. However, the main records should be proof of all sales/takings and also all purchases/expenses, whether they’re paper or electronic documents. These include: all receipts for goods/stock; sales invoices, till rolls and pay slips; business mileage/log; bank statements and chequebook stubs plus your P60 (if you’re also employed).
For traditional accounting your records would also need to include: what you’re owed (but haven’t received yet); outstanding bills (which haven’t been paid yet); value of your stock or work in progress; your end-of-year bank balances and how much you’ve invested/taken out of the business.
All of these records will be written in the tax return as a total but none have to be submitted with your tax return. However, they must be made available to HMRC if necessary.
Income tax payments for the self-employed
In your first year of business, you’ll be taxed from the date you registered as self-employed to the end of the tax year (which may not be a full 12 months). If you owe no more than £3,000 in income tax and are also paid a salary/pension, and as long as you file your return by 30th December, this tax could be collected through your monthly PAYE contributions. This would be much better for you in the difficult period when you’re trying to get your business off the ground as the tax payments can be spread over the year.
Income tax – ‘Payments on account’
After your first full year of business, you’ll need to pay tax for the previous tax year as well as the first instalment in advance for the current year; these are called ‘payments on account’. There are 2 instalments: the first due on 31st January and the second on 31st July.
If you make more money in this period, there will be a third instalment for the balance owed on the following 31st January. On the other hand, if you make less, you’ll receive a tax refund and the size of your payments on account will also decrease for the following tax year.
You might have a single payment due on 31st January but this is only possible if you owe £1,000 or less or you pay more than 80% of your income tax through PAYE.
Self-employed business losses
In a period of financial insecurity, it’s quite possible that you might make a loss on your business in one tax year. In these circumstances, you shouldn’t just ignore the deadline for your income tax since there are penalties for late payments. You should contact HMRC and explain the situation as there are a number of things you could do about your income tax in this situation.
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If you have the cash set aside to pay the tax owed, you could choose to carry the loss forward and set it against any future profits made by the same business. Alternatively, you could use the loss to reduce your income tax for the present or previous tax year. If your profits increase in the following tax year, you may be charged interest if your payments on account were estimated as too low.
Keeping good business records will help you with completing a tax return and you can be fined by HMRC for non-compliance.
The business records you need to keep depend on whether you use traditional accounting or cash basis accounting but are generally proof of all income and expenses.
Income tax payments for the self-employed are generally made in 2 instalments: at the end of July and January.
If your business records a loss, don’t ignore income tax payment deadlines as there are a number of solutions.
National insurance for the self-employed
As well as registering for income tax, you also have to register for National Insurance if you’re self-employed. Failure to do so could mean a fine.
There are 2 types of National Insurance contributions you may have to pay: Class 2 and Class 4.
Class 2 contributions are a flat-rate charge on the self-employed for profits of up to £8,164 and for 2017-18 are £2.85 per week. Changes in the way National Insurance is organised means that they will be abolished in April 2018. Currently, you can claim an exemption if your annual profits are under £6,025.
Class 4 N.I. contributions are based on profits made by your business. The rate is 9% for profits of £8,164-£45,000 and 2% for profits over £45,000. The increases which were due to take effect from March 2017 have now not gone ahead as planned.
How is expenditure for business-related equipment over £200,000 calculated for tax purposes?
As a general rule, any sum spent over £200,000 can be claimed at an annual rate of 18% of the asset’s monetary value. This is known as the WDA or Writing Down Allowance.
How do I know my tax or National Insurance bill for the coming tax year?
HMRC has a self-employed ready reckoner which can be used to check your tax or National Insurance contributions.
What other options are there if my business records a loss?
You could download the HMRC help-sheet HS227 for how business losses can affect your income tax payments and possible solutions.
What does it mean when it talks about my accounting year?
You can choose when your accounting year ends; the advantage of it being early in the tax year means you have more time to do your accounts.
The self-employed and VAT
You only need to pay VAT quarterly if your business turnover exceeds £85,000. This indirect tax must be charged on all goods and services except free services and one-off gifts worth under £50. If you pay a lot of money in VAT for items needed for your business, you could choose to voluntarily register. If you aren’t registered for VAT, you aren’t eligible to reclaim the VAT you’ve paid but when you work out your business-related expenses, you should include the price of the items with VAT for the tax relief.
For self-employed people with a turnover of under £150,000, there is a flat-rate scheme which simplifies your calculations for how much VAT you should pay. Instead of itemising each item, your VAT is worked out as a percentage of your VAT-inclusive turnover.