An introduction to the tax system for the
Key tax issues you need to know about.
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 three ways that you can register:
- Online – visit www.gov.uk for further information.
- Phone – call the Newly Self–Employed Helpline on<br /> 0300 200 3500
- Post – download and complete form CWF1 or use the form incorporated in leaflet SE1 (Thinking of working for yourself?)
Once you become self-employed, the tax rules are quite different from those that may have applied 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. This can be a nasty shock if you haven’t put enough money aside.
We aim to give you as much warning as possible of the likely timing and amount of tax payments, but it is not easy to do this during the first year of your new business, or if you do not keep your records up-to-date.
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 a few minor 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. It may be possible to avoid this by arguing that such items never actually formed part of your stock and showing the original purchase as private expenditure (drawings).
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 a reasonable reward for what is done.
How does HMRC allocate profit to tax years?
The aim of the system is that over the lifetime of your business the profits will be taxed in full, once, and once only. But to make the system fair, there are certain complications you will have to cope with.
The general rule is that the tax for a particular tax year is based on the profits of the twelve months to your accounting date in that tax year. For example, the tax for 2019/20 could be based on accounts for a year ending on various dates ranging from 6 April 2019 to 5 April 2020.
This demonstrates that you get more time for the tax to be worked out if your accounts end early in the tax year, which is why 30 April is such a popular year-end for self-employed people.
How is the tax collected?
What about the complications?
What about National Insurance (NI)?
The self-employed are subject to a two-tier system of national insurance contributions (NICs). Class 2 NICs are at a flat rate of £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 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.
Save for your tax
It is essential that you make proper provision to ensure the availability of funds to pay income tax and Class 4 national insurance. Interest on unpaid tax is chargeable by HMRC, and is not deductible from business profits.
Please call us if you would like further help or advice on this matter.
Cash basis for small businesses
In order 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.