Guide to UK Taxation for the self employed
Commencing self employment?
If you start working for yourself one of the first things that you should do is register with the HM Revenue & Customs. You must register within three months of commencing self employment otherwise you will be liable to a £100 penalty. There are a number of ways to register, online through the HMRC website, by telephone on 08459 15 45 15 or using Form CWF1 available as part of leaflet SE/1 'Thinking of working for yourself'.
Once you have decided to become self employed one of the key differences that you should be aware of is that the tax rules are quite different from those governing the taxation of employees. Unlike employees no tax and national insurance is collected from your earnings at source, you must instead set aside part of your income towards the bills that you will receive. This is something that takes some getting used to but it is important if you wish to avoid an unwelcome surprise. At John M Taylor we aim to give our clients as much warning as possible of the tax payments that will be due each year.
How do HMRC tax your self employment profits?
As a self employed individual you will be required to complete a Self Assessment Tax Return each year disclosing your self employment profit. Your Tax Return will show details of all your self employed income each year less any expenses incurred for the purposes of your trade. However, different expenses are treated in different ways depending on what they relate to.
For example the purchase of capital assets such as motor vehicles or machinery for use in your business will be relieved through the capital allowances regime whereby a percentage of your expenditure is allowed against your income over a number of years. The capital allowances regime applies mainly to longer life assets that have a useful life of longer than one year and the allowable deduction against your income reflects the true lifespan of the asset.
If you take stock from your business for personal use it is treated as a sale at market value and your income increases accordingly. However, it may be possible to avoid this if it can be shown that the item(s) was never actually part of your stock and was instead a private purchase allocated to drawings.
What is the current rate of Tax?
Currently tax is payable at the following rates on earned income:-
| Earnings | Tax Rate |
|---|---|
below £5,225 |
Tax Free |
£5,226 - £7,455 |
10% |
£7,456 - £34,600 |
22% |
£34,601 & above |
40% |
What is my accounting period?
Once you commence self employment you are free to choose whatever accounting period you choose. There are a number of factors you should consider when doing this as it can bear an influence on the tax payable in the early years of your trade. Over the entire period of your self employment the total Tax and Class 4 National Insurance payable should be the same regardless of your accounting period (subject to consistent tax and national insurance rate bands). If you do not have a 5 April year end then the general rule is that you pay tax on your profits during the twelve months ending on your accounting period end date arising in that tax year. If your year end is 31 December 2006 then your taxable self employment income for the 2006/07 tax year is your taxable profit arising during the year ending 31 December 2006.
How does HM Revenue & Customs collect my tax payments?
As mentioned above self employed individuals have to complete a Self Assessment Tax Return each year. Tax Returns are issued for each tax year with every tax year ending on 5 April. For example the 2006/07 Tax Return will be issued in April/May 2007 and must be submitted 31 October 2007 if submitted on paper and by 31 January 2008 if filed online. If you submit your Tax Return late automatic penalties will be applied.
Important - If you want HM Revenue & Customs to calculate your tax for you your Tax Return must be lodged by 30 September 2007. Otherwise you will have to calculate your own tax.
If you started trading in 2006/07 your first Tax Return will be for for the year ended 5 April 2007. The total Tax and Class 4 NIC due for the year ended 5 April 2007 will be payable at 31 January 2008. Also payable at this date will be the first payment to account for 2007/08 with a further payment to account due at 31 July 2008. Payments to account usually take the form of 50% of the previous tax years liability unless they are reduced. Payments to account can only be reduced if you have reason to believe that your tax liability for the current tax year is lower than in the previous tax year.
If you do not make these payments on time interest and surcharges will be applied to your account.
What happens in my first year of trading?
In your first year of trade you may not actually have traded for a full twelve months. In this case your taxable self employment income is your taxable profit for the period ending 5 April. For example you may start trading on 1 January 2007 and choose to have a 31 January 2008 year end. This would mean that during 2006/07 you would be assessed on your profit attributable to the period ending 5 April 2007. In 2007/08 you would be assessed on the 12 months ending 31 January 2008. Say for example the taxable profit for your first period of trading was £19,500 your income would be assessed as follows:
2006/07 - 1 January 2007 to 5 April 2007 - 3/13 x £19,500 = £ 4,500
2007/08 - 1 February 2007 to 31 January 2008 - 12/13 x £19,500 = £18,000
You may notice from the above example that your profits during the period 1 February to 5 April 2007 will be taxed twice. The profit for this period is known as 'overlap profit' and relief for this overlap period will be given when your business comes to an end. If you ceased trading at 5 April 2015, having made a profit of £25,000 during your final year of trading, this relief will be given as follows:-
2014/15 - Profit for year ending 5 April 2015 -£25,000
Less overlap relief - £3,000Profit for year ended 5 April 2015 - £22,000
What about National Insurance?
Self Employed people pay national insurance on their earnings in a different manner to employed people. As self employed people's earnings may fluctuate from year to year their entitlement to state benefits could potentially be effected if they made a loss. To safeguard their entitlement to such benefits self employed individuals pay a Class 2 National Insurance stamp of £2.20 per week (currently). In addition to this they also pay Class 4 National Insurance of 8% of their earnings between £5,226 and £34,840 with any earnings over this amount attracting a National Insurance charge of 1%.
Key Points
We hope that you have found this guide useful. If you would like some further advice or assistance please contact us.
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