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.