Leaving the secure world of employment can be daunting as you are now responsible not only for keeping the company afloat and possibly paying wages but also for all tax, legal and compliance issues. All the same, for one reason or another, many Brits run their own companies. In fact in 2022 sole traders – also known as the self-employed – made up 74% of the 5.5 million or so businesses operating in the UK.
Where do I start?
Most people set up as sole traders rather than as limited companies and it is the former that this article is concerned with. Self-employment is appealing in many ways: you don’t have a boss, you can manage your own time, you don’t have to ask permission to take an afternoon off and you are the one who makes all the decisions. But the flip-side is having to be responsible for running the company and all the admin that goes with it, in particular keeping financial records and making sure the correct tax is paid.
You don’t need to pay corporation tax as a sole trader but you do need to pay income tax in the same way that you did when you were employed. However, there are a number of reliefs and allowances you can claim that are not available to the employed. Therefore it is vital that you are aware of these so that you are not throwing away money paying tax that you could be keeping as profits.
My first tax return
Paying tax is done by what is known as self assessment or filing a tax return. To start with, you need to register with HMRC via its website. It will then post you a unique taxpayer reference, a 10-digit number required every time you login to the site. Registering with HMRC should be done no later than 5 October in the year your first tax year ended, which would have been on the previous 5 April. You then have until 31 January to file your tax return and pay any tax due. You will only pay tax if you earned more than £1,000 (before deducting any allowances) over the tax year.
Over the course of each tax year (tax years always end on 5 April and start on 6April) you should keep records of all your business outgoings and income, whether paper, digital or a mixture of both.
One tip that many sole traders have benefited from is to do their tax return soon after the end of the tax year in April. Importantly, the tax bill does not become due when the self assessment has been completed and the amounts owing calculated – the 31 January deadline remains the same. This method avoids nasty surprises in January when a self assessment calculated near the deadline turns out to be much more than was expected.
Payments on account are a major component of any future tax bill and must be budgeted for. To take the last tax year as an example, sole traders would have been asked to pay a big chunk of their tax bill for April 2022-April 2023 in January 2023, which could be as much as half of it. Then they would have been asked for most or all of it by 31 July 2023. If all has gone according to plan, most of the January 2024 tax bill should be the first payment on account for the 2023-24 tax year.
Calculating your tax bill soon after the end of the tax year is vital to budgeting how much money needs to be set aside each month. And your accountant will be glad of not being given the job over November, December and January when everyone else is asking for their tax to be worked out. The extra time will allow you and your accountant more opportunity to correct any errors and make sure you have tracked down every last receipt and allowance.
Furthermore, prompt filing means you will not have to pay late penalties and charges. Late filing attracts an initial £100 penalty and if your return is more than three months late there is a daily penalty of £10 up to a maximum of £900.
If you think your earnings this tax year will be less than the previous one this is another reason to do your return early. Doing so will bring down the second payment on account in July, which would otherwise have been based on the previous year’s higher income.
Conversely if your income is higher this tax year it would be worth considering filing your tax return after 31 July so that the second payment on account is based on the lower previous year’s figure, given you more time to set aside sufficient funds.
What records do I need?
If you do go down the accountants’ route for your first assessment, you will need to submit:
- details of all income received. This can be in the form of bank statements and receipts.
- details of any income from employment in the case of those working for an employer alongside running their business;
- dividends. While not business income, dividends are subject to income tax so should be included;
- rental income in the case of landlords. HMRC is interested in all your income, not just that from your business;
- private pensions. These are eligible for tax relief so should be included; interest on savings, excluding tax-free ISAs; any other income.
Different rules apply for subcontractors and contractors in the construction industry, who should register with HMRC’s Construction Industry Scheme (CIS). Contractors in the scheme take money from payments to subcontractors and pass it to HMRC in the form of PAYE tax, national insurance and CIS deductions. Subcontractors who register with the scheme have lower rates of payment.
You can be a sole trader and employ other people; however, you must collect income tax and national insurance from them.
As a sole trader you should be paying class 2 national insurance if your profits are more than £6,725 a year at a weekly rate in the 2023-24 tax year of £3.45.If your profits are between £12,570 (your personal tax allowance) and £50,270 a year you should also pay class 4 national insurance at 9%. For profits over £50,270 the NI rate is 2%. How much you should pay is calculated for you by HMRC.
If your turnover exceeds £85,000 a year you must register for VAT. This means you charge VAT on VAT-able sales to customers and pass it along to HMRC but you can also reclaim it on VAT-able expenditure.
Ideally you should open a separate bank account for your business; however, unlike a limited company that must have a business bank account, which has monthly charges, you can operate using a normal current account, and most banks offer fee-free accounts.
Cash basis
Before long in your life as a sole trader you will come across the phrase ‘cash basis accounting’. But what is it?
Essentially, this is a simple, ‘real world’ way of doing your accounting. You only record the actual income that goes into your business bank account in a given tax year so invoices unpaid at the end of 5April won’t count for that tax year. Similarly, you only record expenses when the money to pay for them has left your bank account.
You can still claim a range of expenses using cash basis, for example, the normal running costs of your business, such as utility bills, stationery, goods bought for resale and things you need for your business like computers, a van or machinery.
The alternative to cash basis is accrual accounting, which counts revenue when it is earned, eg, when a product is delivered rather than when payment for it is received. Similarly, expenses are counted when they are incurred rather than when they are paid for. Larger companies are obliged to use accrual accounting.
So what is best for me?
While many sole traders do their own tax return it is particularly worthwhile asking a firm of accountants to do it for you if you are starting out in business.
The online HMRC forms are complex to navigate, some of the questions need some expertise and knowledge to understand and answer correctly, and there is always the risk of mistakes leading either to overpayments or underpayments that result in interest being charged on unpaid tax or – even worse – penalties. Even traders with quite a modest income may well save more on their tax bill by having it calculated correctly than they spend on accountancy services. They also have the peace of mind that comes with knowing the job has been done correctly.
The accountants at Finsbury Robinson will be happy to help you get your business running in the most tax efficient way. Please give one of our friendly team a call on 0208 858 4303 or email us at info@finsburyrobinson.co.uk
