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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 (http://www.hmrc.gov.uk/selfemployed/register-selfemp.htm), 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 & Co 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?
For the 2013/14 tax year tax is payable at the following rates on earned income:-
£9,440 - £41,450
41,450 & above
150,000 & above
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 2012 then your taxable self employment income for the 2012/13 tax year is your taxable profit arising during the year ending 31 December 2012.
How does HM Revenue & Customs collect my tax payments?
- Self Assessment
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 2012/13 Tax Return will be issued in April/May 2013 and must
be submitted by 31 October 2013 if submitted on paper and by 31 January
2014 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 31 October 2013, otherwise you will have to calculate your own tax.
- Payment of Tax
If you started trading in 2012/13 your first Tax Return will be
for the year ended 5 April 2013. The total Tax and Class 4 NIC
due for the year ended 5 April 2013 will be payable at 31
January 2014. Also payable at this date will be the first
payment to account for 2013/14 with a further payment to account
due at 31 July 2014. 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 15 January 2013 and choose to have a 31 January 2014 year end. This would mean that during 2012/13 you would be assessed on your profit attributable to the period ending 5 April 2013. In 2013/14 you would be assessed on the 12 months ending 31 January 2014. Say for example the taxable profit for your first period of trading was £19,500 your income would be assessed as follows:
2012/13 - 15 January 2013 to 5 April 2013 – 2.5/12.5 x £19,500 = £ 3,900
2013/14 - 1 February 2013 to 31 January 2014 - 12/12.5 x £19,500 = £18,720
You may notice from the above example that your profits during the period 1 February to 5 April 2013 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 - £3,120
Profit for year ended 5 April 2015 - £21,880
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 £2.70 per week (in 2013/14). In addition to this they also pay Class 4 National Insurance of 9% of their earnings between £7,755 and £41,450 with any earnings over this amount attracting a National Insurance charge of 2%.
- Penalties and interest are payable if either your Tax Return is late or your tax payment is late.
- If you fail to register with HMRC within three months of starting self employment a £100 penalty will be charged.
- Your Self Assessment Tax Return must be lodged with HMRC by 31 October if you want your tax liability to be calculated for you.
- The 2012/13 filing deadline is 31 October 2013 for paper Tax Returns or 31 January 2014 if you file your Tax Return online.
- Your Tax liability for 2012/13 will be due for payment on or before 31 January 2014 along with a further 50% as a payment to account for 2013/14.
We hope that you have found this guide useful. If you would like some further advice or assistance please contact us.