Setting up your own business gives you more control of your working life and ideally the chance to do what you find most fulfilling but it does mean you have to actively manage your finances in a way that the person on PAYE does not have to.
In particular, to make your business as profitable, as possible it is worth looking hard at how you can reduce your liability for tax.
The most significant way to reduce your self-assessment tax bill is likely to be by claiming allowable expenses. You deduct these from your turnover when working out your tax bill so that only your income net of deductions is taxable. The rules for limited companies are different and here we focus only on the self-employed.
Operating Expenses
Office costs
These include rent, rates, insurance, utilities, stationery, phone bills and so on. Only the proportion of the expense that is used for the business can be claimed for. Software and consumables are allowable expenses.
Capital expenditure is not seen as a claimable expense by HMRC. Thus repairs to a business item can be claimed but replacing or significantly improving the item cannot. Furthermore, altering an item to perform a different task is not an allowable expense nor is expense on making good an item bought in poor condition.
Clothing costs
Unfortunately this does not include suits, dresses, shirts, blouses and the like, even if they are used solely for work. But you can claim for uniforms, labelled outfits, protective gear and costumes, such as those that are used by actors and entertainers.
Staff expenses
These are usually claimable and include employee and staff salaries, bonuses, pensions, benefits, agency fees, payments to subcontractors, employer’s national insurance and business-related training. However, training courses aimed supporting setting up a new business or expanding into new areas are not claimable. Domestic help and childcare, even they enable you to run your business, are not claimable.
Materials and produced goods
The costs of buying stock and raw materials are allowable business expenses, so are the direct costs of producing goods. You cannot claim for goods bought for private use.
Legal and financial costs
Professional fees are claimable as are premiums for professional indemnity insurance. But you cannot claim for fines and legal expenses relating to breaking the law or any legal costs incurred for buying property and machinery.
Financial costs
Quite a few business financial costs and charges are not claimable expenses. You cannot claim for:
- overdrafts and credit card interest and charges;
- loan interest;
- hire purchase interest;
- leasing payments; and
- payments made under alternative finance arrangements.
But self-employed people using cash basis accounting can claim up to £500 in interest and bank charges.
Marketing
Businesses can claim for their marketing expenses. So, advertising, bulk mailouts, free samples and website costs are claimable. But hospitality is not even if it is genuinely for business purposes.
Subscriptions
Claims can be made for subscriptions to trade and professional journals (HMRC has a list of eligible subscriptions) and for membership fees for trade or professional bodies if relevant. Gym memberships are not claimable.
Motor and travel costs
You can claim travel costs related to your business. This includes motor insurance, servicing and vehicle repairs, fuel, parking, hire charges, vehicle licence fees and breakdown cover. In addition you can claim for public transport costs including taxis. You can also claim for hotel rooms and meals on overnight business trips. But you cannot claim for commuting costs. And you cannot claim for fines or legal expenses incurred for motoring or other infractions. Non-business travel in a business vehicle is also not claimable.
HMRC gives people the option of making a flat rate claim for their van, car or motorcycle costs. This is known as simplified expenses.
You can claim 45p per mile for the first 10,000 miles driven in a car or goods vehicle and 25p per mile beyond that. For a motorcycle you are entitled to 24p a mile regardless of mileage.
You can claim flat rate for one business vehicle and actual expenses for another but you cannot switch a vehicle from flat rate to actual expenses.
The purchase cost of a vehicle is capital expenditure and is not an allowable expense.
Use of home
You can claim for costs relating to the business use of your home. This is done by means of a flat rate system that is available to people who work more than 25 hours a month at home.
Those working 25 to 50 hours a month at home can claim £10 a month, those on 51 to 100 hours a month can claim £18 a month and those working 101 hours or more a month can claim £26 a month.
Alternatively you can claim for actual expenses incurred. For example your electricity and gas bills would be claimable for the areas that you work in for the periods that you are working and to the extent that you use these utilities for work purposes. Business use of your mobile phone would also be claimable.
People who live at their business premises, for example, if they run and a bed and breakfast, have to deduct their living costs from their allowable premises expenses and can use simplified expenses to do so.
HMRC requires a £350 deduction for personal living expenses for one person, £500 for two and £650 for three or more people. Thus, if one person lived full-time at a business premises, he or she would have to deduct £4,200 (£350 x 12) from the claim for property expenses.
Incorporation
A limited company is likely to pay less tax than a sole trader. If you set up your business as a limited company and appoint yourself as a director you can then pay yourself in dividends. These attract lower tax rates.
Instead of the income tax rate of 20% you would pay the 8.75% dividend tax rate; the equivalent dividend rate on 40% tax is 33.75% and on 45% it is 39.35%.
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