Here is an overview of some of the main things to consider.
Registering with HM Revenue & Customs (HMRC)
If you start working for yourself, you must register with HMRC by 5 October following the end of the tax year in which your self-employment starts. Otherwise, you may be liable to penalty based on the tax due to HMRC.
There are two ways that you can register:
- Online – visit www.gov.uk/log-in-file-self-assessment-tax-return/register-if-youre-self-employed
- Phone – call the Newly Self–Employed Helpline on 0300 200 3500
Once you become self-employed, the tax rules are different from those that you may have been used to when you were an employee. Instead of tax (and national insurance) being deducted from your earnings at source, you must be prepared to receive a bill at some time in the future. We can advise you on what money you should set aside for your tax bills.
What profits do HMRC tax?
The starting point for the calculation of taxable profits is your profit and loss account. In calculating taxable profits, you are entitled to claim deductions from your business income in respect of any expenses incurred for the purposes of trade (with some exceptions).
When you buy equipment for your business, you will be entitled to deduct the full cost (up to a maximum of £1 million per year). For most cars, you can deduct only a proportion of the cost for each year you own them and use them in the business.
If you take stock for your own use, the disposal should be shown in the accounts at market value, and not at original cost.
Tax is payable on the whole of the profits of a trade, and so payments for your own ‘wages’ (drawings) are not deductible. However, if your spouse works in the business, the wages are an allowable deduction, provided they are actually paid and are what you would expect to pay an unrelated employee for the same role.
It is good to review what year-end date would be best for your accounts to be drawn up to. For many, it is best to stay with the tax year-end of 31 March/5 April.
How is the tax collected?
Tax returns covering income for the year ending 5 April have to be submitted to HMRC by the ‘filing date’ which is 31 October for paper returns and 31 January for online returns. The return will include a self-assessment of your liability to income tax and capital gains tax.
There are automatic penalties for late filing of tax returns.
Payment of tax
Payments on account of income tax and Class 4 national insurance contributions (NICs) will be due on 31 January and 31 July. These interim payments will be based on one half of the total liability (less any tax deducted at source). You will have the right to reduce payments on account if you believe the income tax for the following year will be lower.
The balance of income tax for a tax year is due on the following 31 January (along with the first payment on account for the following tax year and any capital gains tax due as well).
Interest and penalties will be levied for late payment.
The self-employed are subject to a two-tier system of national insurance contributions (NICs). Class 2 NICs are at a flat rate (currently £3.00 per week if earnings exceed £6,365 per annum).
Payments for self-employed Class 2 NICs are due on 31 January following the end of the tax year.
Profits between £8,632 and £50,000 (current rates) are subject to Class 4 NICs at a rate of 9%. Any excess of profit above £50,000 is subject to Class 4 NICs at the rate of 2%, without any upper limit. Class 4 NICs are collected by HMRC and are payable at the same time as the instalments of income tax.
Cash basis for small businesses
To try and simplify the calculation of taxable income for small businesses, HMRC introduced an optional alternative system for eligible unincorporated businesses. Such businesses may calculate taxable income figures on a simpler cash basis if this suits the business. They will not have to compile figures of debtors, creditors and stock, or distinguish between ‘capital’ and ‘revenue’ expenditure and will not have to compute capital allowances to arrive at taxable income.
A second measure allows all unincorporated businesses to choose to use flat rate expenses for particular items of business expenditure.
Last updated: 17.11.2020
Whilst the information in this document is correct; you should always obtain individual advice from a qualified accountant.