There are over five million self-employed people in the UK, and this number has grown considerably in recent years. This is not an insignificant number and it goes to highlight just how many people are making the move to self-employment or would like to know a bit more about the tax and benefits involved before making the switch.
Although there are a number of necessary steps to take when setting yourself up as self-employed, there is no standard template to follow as many of the obligations are dependent on your unique circumstances – the structure of your business; sector you work within; place of work; whether or not you have employees; and the nature of your sales and income.
There isn’t just one way of working for yourself either, you could set yourself up as a sole trader, become a partner in a business partnership or set up your own limited company. It is important to ensure you choose a business structure that is the most suitable for your circumstances including, among other issues, your tax position. M+A Partners can advise on the different options available, to ensure the business is set up efficiently and meets your needs from day one.
The sole trader route tends to be the most popular when starting a small business, therefore I have set out below the main issues/obligations to consider when setting up a sole trade.
Setting up as a sole trader
Sole traders run their business as an individual and are self-employed – they keep all of their business profits (after tax) and are personally responsible for any losses.
You will need to set up as a sole trader with HMRC if you earned more than £1,000 from self-employment between 6 April 2020 and 5 April 2021.
Once you are set up as a sole trader, you will need to file a tax return every year. You can register for self-assessment here.
Notifying HMRC of your self-employment
As mentioned above, you must advise HMRC when you become self-employed, either as a sole trader or partnership. This is a fairly straightforward process and can be completed in the Government’s online registration portal.
Once you have registered, HMRC will send you a letter with your 10-digit Unique Taxpayer Reference (UTR) and will set up your online account.
You need to register by 5 October, after the end of the tax year in which you became self-employed. For example, if you became self-employed in August 2020, you would need to register with HMRC by 5 October 2021.
Record-keeping
You will need to keep
- Records of your business’s sales, income and expenses to enable you to complete and submit your self-assessment tax return. These records will enable you to work out your profit or loss for your tax return; and
- Proof of all receipts for goods, stock and expenses; bank statements; sales invoices; till rolls; and bank slips.
You should consider how you will keep your records, for example will you maintain a written list, an excel spreadsheet or use accounting software?
Do bear in mind from April 2023, HMRC have announced that sole traders with turnover of over £10,000 will be required to maintain their records electronically to comply with Making Tax Digital (MTD). Therefore, you may want to consider keeping your records this way from the outset.
Expenses
As a self-employed individual, you are able to deduct some of your costs to calculate taxable profit – as long as these are allowable expenses. You will need to keep records of all of your business expenses.
Some of the costs you can claim as allowable expenses include :
- Office costs – stationery or phone bills;
- Travel costs – fuel, parking, train or bus fares;
- Clothing costs – uniforms;
- Staff costs – salaries or subcontractors;
- Things you buy to sell on – stock or raw materials;
- Financial costs – business insurance or bank charges;
- Business premises – heating, lighting, business rates;
- Advertising or marketing costs – website; and
- Training courses – ongoing updates related to your business.
It is important to note a business can incur various expenses which are not allowed for tax, either due to legislation or court cases won by HMRC (for example entertaining customers or certain gifts).
Year end
Sole traders can choose their own year end, however before deciding on this they need to consider the opening year rules and the complex issues that surround this. The year end chosen can affect the tax payable.
Most sole traders have a 31 March or 5 April year end to avoid complication and to keep things as simple as possible. We discuss the optimum year end with our clients prior to the first set of accounts being prepared.
Income Tax
As a sole trader, you will need to pay Income Tax on your profits. How much Income Tax you pay depends on how much of your income is above your Personal Allowance and how much falls into each tax band. Click here to view the Income Tax rates and bands.
The standard Personal Allowance is £12,500 for the 2020-21 tax year – this is the amount of income you do not have to pay tax on. It should be noted that you have only one Personal Allowance to use against all personal income sources.
The current tax year runs from 6 April 2021 to 5 April 2022.
The Self-Assessment tax return is the system HMRC uses to collect Income Tax.
National Insurance
There are two types of National Insurance if you are self-employed, the amounts below are for the 2020-21 tax year:
- Class 2 if your profits are £6,475 or more a year; in addition to
- Class 4 if your profits are £9,500 or more a year.
The rates for the tax year 2020-21 are :
- Class 2: £3.05 a week; in addition to
- Class 4: 9% on profits between £9,500 – £50,000 and 2% on profits over £50,000.
National Insurance is paid through your self-assessment tax return.
VAT registration
If your turnover from taxable supplies exceeds £85,000 in any 12-month period then you must notify HMRC of your liability to register for VAT. Taxable supplies are supplies of goods and services that are subject to VAT at the standard rate (20%), reduced rate (5%), or zero rate (0%).
If you do exceed the £85,000 limit, you are required to notify HMRC within 30 days, late notifications may be subject to penalties.
You may not have to register if you have exceeded the £85,000 limit just because of a one-off exceptionally large transaction for your business, or if you only or mostly make zero rate supplies. However, you still have to notify HMRC that you have exceeded the £85,000 limit within 30 days and will need their authorisation that you do not have to register.
You can also register voluntarily if this suits your business requirements and you have taxable supplies, for example if you sell to other VAT registered businesses and want to reclaim the VAT you have incurred on your business expenses.
Making Tax Digital
If your taxable supplies are over £85,000 then you must also follow the requirements for Making Tax Digital (MTD) – find out more here.
VAT-registered businesses, with taxable supplies of below £85,000, will be required to follow Making Tax Digital rules for their first return starting on or after April 2022.
Once you have registered for VAT, you must make sure you charge the correct amount of VAT, pay any VAT due to HMRC, submit VAT Returns and keep VAT records and a VAT account.
Please note if you are VAT registered and have taxable supplies as well as exempt supplies, it is not straight-forward and you need to do complex calculations to determine what VAT can be reclaimed on your business expenses. These calculations are called partial exemption, the team at M+A Partners will be able to provide advice on this.
Employing others
If you use the services of others, you need to determine whether each relationship is one of an employee/employer relationship or self-employed/customer relationship. It is important to remember, it does not matter what you call the relationship – it is what happens in practice that counts.
If the relationship is that of an employee/employer relationship, you will need to determine whether you need to register for PAYE. This will depend on the level of salary the employees receive as well as what other personal income they have. You must still keep payroll records even if you are not required to register for PAYE.
Construction Industry Scheme
It is estimated that around a fifth of the UK’s self-employed work within the construction sector. This means a big consideration for many people would be the Construction Industry Scheme (CIS).
If you are self-employed and working in the construction industry as a contractor, you must register for the CIS. Subcontractors do not have to register, although it is recommended that they do, as failure to register within the CIS may result in deductions being taken from their gross payments at a higher rate.
The CIS determines that on making a payment to a sub-contractor under a construction contract, the contractor must deduct a certain percentage of the payment on account of tax. Find out more about the scheme here.
If you make and/or receive supplies of construction services, where payments are required to be reported through the CIS, then you may need to be aware of the new reverse charge for VAT.
To find out more about the tax requirements when setting yourself up as self-employed, contact a member of the M+A Partners team or email enquiries@mapartners.co.uk and we will be happy to help.
