What is the self assessment system?

The UK operates a system where taxpayers are trusted to provide HMRC with accurate financial information – hence it is known as ‘self’ assessment. HMRC will usually accept the information as true but will investigate if it suspects the information is incorrect.

How is my tax calculated?

Generally speaking, your various sources of income (PAYE employment, interest, dividends, property, pensions, profits from self-employment etc) are added together to determine your ‘total income’ for the year. Your personal allowance is then deducted from this to produce your ‘taxable income’. Tax and National Insurance is then charged on this figure.

We will provide you with a tax computation each year which details your income, the taxable income and shows how the income tax and NI rates are applied to it. We will also include detailed working papers.

Profits on ‘capital gains’ are not included in the above and are taxed separately.

What is a personal allowance?

This is the amount you can earn each year without paying tax. It is set annually in the Budget by the Chancellor and is the same amount for everybody.

What is a tax code?

This is issued by HMRC to employers and pension providers (but not the state pension) telling them how much you can earn before they have to start deducting tax. They pay any tax deducted to HMRC on your behalf.

Generally speaking, the number in your tax code is the amount of income you can earn tax-free divided by ten. So, for example, a tax code of 750L tells an employer you can earn £7,500 before they start deducting tax.

If you have more than one employment then HMRC may split your personal allowance between the employments by allocating a lower tax code to each of them. The total of the tax codes should add up to your full personal allowance.

How is tax deducted?

Some income such as PAYE employment and bank interest has tax deducted ‘at source’ i.e. before you receive it. Other forms of income that do not have tax deducted at source are included on your tax return and HMRC will issue you with an assessment to pay any tax due when they receive it.

PAYE employment – tax is deducted at source by your employer, based on the tax code HMRC send them

Bank interest – for individuals, bank and building society interest has tax deducted at source so you receive the net payment. The amount should still be declared on your tax return but will not incur further tax unless you are a higher-rate taxpayer

Dividends – are received tax-free for basic-rate taxpayers, although higher-rate taxpayers will have to pay additional tax on the amount falling into the higher rate band

Pensions – the state pension is not taxed at source but receipts from other pensions usually are. The pension providers will work the tax out using a tax code that will be sent to them by HMRC (see above)

Self-employed – trading profits are included in your taxable income

Property income – profits from renting properties are also included in your taxable income.

How do National Insurance Contributions work?

There are four different ‘classes’ of NI:

• Class 1 – charged on PAYE income
• Class 2 – fixed weekly amount paid by the self employed (usually paid quarterly by direct debit)
• Class 3 – additional voluntary contributions
• Class 4 – charged on self-employed profits.

 

Self-employed only – Payments on Account?

Probably nothing causes self-employment taxpayers more trouble than payments on account. They arise because of timing differences.

Consider the following: a self-employed trader starting business on 1st May 2010 will include their taxable profits on their tax return covering the period 6 April 2010 to 5 April 2011. This needs to be submitted and any tax paid by 31st January 2012. Consequently money earned in May 2010 does not need to have the tax paid until 31st January 2012 – effectively 20 months later! HMRC claim that this is unfair on PAYE taxpayers who have to pay their tax and NI at the end of each month.

To remedy this HMRC make the self-employed also pay the tax for the following year in advance (‘on account’). They base this figure on the current year’s tax, so effectively this is doubled. The total amount of tax is then reduced by any payment made ‘on account’ last year for this year.

So each year you have to pay: the tax for the current year plus the same amount in advance for next year less any tax paid in advance last year for this year’s tax. As we say, nothing causes self-employment taxpayers more frustration.

However, payments on account do not need to be made if the tax for the current year is less than £1,000.

When is the tax payable?

Individuals have to pay the tax for their tax year ending on 5 April each year by the following 31 January.

How do I pay my tax?

HMRC will accept payment in almost any way. Details are at www.hmrc.gov.uk/payinghmrc/selfassessment.

If you wish to pay by cheque HMRC will have sent you a payslip when they wrote to you reminding you that you have to complete a tax return for the year.

If you do not have a payslip but want to post a cheque then make the cheque payable to ‘HM Revenue & Customs only’ and write your tax reference number immediately after this (it will not stop the cheque being cashed) followed by the letter ‘K’ (this ensures HMRC allocate it to your self assessment tax account and not a PAYE or VAT account.

Send the cheque to HM Revenue & Customs, Bradford, BD98 1YY. NOT a local tax office.

Individuals

• Trading summary – if your only income is from trading then the minimum we need for your tax return is your sales and expenses in the period – broken down by their main headings. If you require separate business accounts preparing please see the section on Business Accounts below
• Employments – please provide a P60 for each employment (this is the annual summary covering the tax year which employers are required by law to provide). If you don’t have one you should contact your employer and ask for a copy
• Bank interest – this will be on your statements. if the amount is negligible you can usually ignore this as basic rate tax is deducted at source
• Dividends – preferably we would like to see the dividend statement. But if this is not available let us know the amount you received – it should show on your bank statement
• State pension – please let us know the amount you received each week/month. Please note it is the payments received in the tax year up to the last 5 April – the payments may have gone up since then
• Other pensions – please let us have a copy of the annual statement – your pension provider should send you one of these. If you do not have one you should contact your pension provider for a copy
• Other income – please let us know details.

Business accounts

If you want business accounts preparing we will need more detailed information:

• Bank statements – preferably with a breakdown of what the individual items are. If you have online banking you can download a summary of your transactions into a spreadsheet or as a pdf
• Cash payments or receipts – a breakdown of what these are
• Sales – a list of your sales invoices
• Year-end debtors – any sales invoices issued in the year but unpaid at the year-end (the company’s debtors)
• Year-end creditors – any purchase invoices that relating to the year but had not paid at the year-end (the company’s creditors)
• Mileage – There are 2 ways of claiming for your mileage. You can either claim for the actual expenditure, so the payments will be in the expenses above. Or, you can claim the official mileage rate in which case you will need to let us know how many business miles you drove in the year
• Fixed assets – details of any fixed assets purchased or sold in the period. Fixed assets are purchases that you expect to last for several years i.e. vehicles, plant and machinery, computer equipment. This does not include minor or consumable items such as computer equipment or sundry tools.
• Computer-based accounts – if you keep your records on a computer-based accounting system then please send us a copy of your trial balance, profit and loss account, balance sheet, and a copy of the nominal ledger. If you are not sure the figures are accurate then we can check them if you send us your bank statements

Limited companies

We will need details of:

• Directors who joined or left in the year
• Changes to any company or directors details: address, names, nationality
• Loans to/from directors
• Copies of HP or finance contracts.

And don’t worry – just give us a call if you get stuck!

Overview

The trading profits of self-employed businesses are added into the owners ‘total income’ for the year along with any other income they may have and this figure is then subject to the normal tax rules. (see our article The Tax System: An Overview for Individuals.)

What expenses can I claim?

The HMRC definition includes all expenses incurred ‘wholly, necessarily and exclusively’ for the business. We recommend you look at all your expenditure and ask yourself if there is a business element. If so all, or a proportion, of it may be claimable. If in doubt, include the amount in your expenses and tell us the details at the year end.

We have a comprehensive list of the expenses that businesses are usually able to claim on this website in our Expenses Checklist article.

How are my profits taxed?

The profit shown in the accounts sometimes has to be adjusted to determine the ‘taxable profit’. This might include disallowing part of the expenses paid by the business if there is a personal (non-business) element. Another common adjustment is for depreciation (not allowed against tax) and capital allowances (allowed – see our article Capital Allowances for a brief explanation). You do not need to worry about these – we will work them out and provide you with a computation detailing the adjustments.

What are Payments on Account?

Probably nothing causes self-employed taxpayers more trouble and frustration than payments on account. They arise because of timing differences.

Consider the following: a self-employed trader starts business on 1st May 2010. They will include their taxable profits on their tax return covering the period 6 April 2010 to 5 April 2011. This needs to be submitted and the tax paid by 31st January 2012. Consequently money earned in May 2010 does not need to have the tax paid until 31st January 2012 – effectively 20 months later! HMRC claim that this is unfair on PAYE taxpayers who have to pay their tax and NI at the end of each month.

To remedy this HMRC make the self-employed pay the tax on any trading profits for the following year in advance (‘on account’). They base this figure on the current year’s tax, so effectively this is doubled. The total amount of tax is then reduced by any payment made ‘on account’ last year in advance for this year.

So each year you have to pay: the tax for the current year plus the same amount in advance for next year, less any tax paid in advance last year on account of this year’s tax. As we say, nothing causes self-employed taxpayers more frustration.

However, payments on account do not need to be made if the tax for the current year is less than £1,000.

The big question – Should I be a limited company?

There are advantages as trading a limited company rather than as self-employed.

The company can pay dividends out of taxed profits. The benefit is that dividend income does not attract National Insurance. As such it is a much more tax-effective way of being paid as compared to PAYE income or being self-employed.

Rough figures: a self-employed trader earning taxable profits of £15,000 would pay 8% of this (£1,200) in Class 4 National Insurance – for which they get no benefit, it is effectively just another tax. If they converted to a limited company they would save this amount. However, the accountancy fees would usually be around £250-350 higher – but certainly not £1,200!

Additionally, if the company is sued then this is not the personal responsibility of the directors or shareholders. A limited company is a wholly separate legal entity – and if it goes bust then any debts are not the liability of the director or shareholder. For many businesses this is a significant benefit, and may justify converting to a limited company on its own.

How do I pay my tax?

HMRC will accept payment in almost any way. Details are at www.hmrc.gov.uk/payinghmrc/selfassessment.

If you wish to pay by cheque then HMRC will have sent you a payslip when they wrote to you reminding you that you have to complete a tax return for the year.

If you do not have a payslip but want to post a cheque then make the cheque payable to ‘HM Revenue & Customs only’ and write your tax reference number immediately after this (it will not stop the cheque being cashed) followed by the letter ‘K’ (this ensures HMRC allocate it to your self assessment tax account and not a PAYE or VAT account.

Send the cheque (we recommend by recorded delivery) to HM Revenue & Customs, Bradford, BD98 1YY. NOT a local tax office.