Entering the world of self employment and being your own boss is extremely exciting. The one downside is dealing with the bureaucracy and regulation that running a business brings. Whatever the size or structure of your business dealing with your accounts and tax returns comes with the territory. It can all seem daunting and overwhelming at first. Here’s a few tips to get you started.
When do I have to register with HMRC?
As soon as you start to trade or operate your business you’ll need to register with HMRC. It might not always be clear when your business formally starts as you may have some pre-launch tasks to do, stock to buy or contracts to secure. Unfortunately HMRC isn’t much help here as they do not provide a clear definition of starting to trade and when you ought to register with them.
The best approach is to register with HMRC sooner rather than later. You can do this online at https://www.gov.uk/log-in-register-hmrc-online-services/register.
You can claim for pre-launch costs incurred through your business even if they were paid out of your own funds. Keep receipts and invoices then record the amounts spent in the accounts.
Should I set up as a Sole Trader or Limited Company?
By far the simplest of structures is that of a sole trader; a self-employed person working on their own. There is no formality to setting up as a sole trader as there is no distinction between you and your business; basically you just get started.
It is worth noting that a sole trader (an unincorporated business structure) has unlimited liability which means that you are personally liable for the debts of the business should it fail. Creditors (people or businesses that you owe money to) could attempt to recover any amounts owed to them from your personal assets including your house.
The fear of unlimited liability is often a reason for a business to be set up as a limited company; an incorporated business established through a formal process and registered at Companies House. A limited company has its own separate identity in the eyes of the law meaning that it is very important to keep the financial affairs of the business completely separate from your own finances.
Ownership of a limited company is by way of shares allocated to and purchased by shareholders. The shareholder(s) appoint director(s) to run the business on their behalf. Directors have legal obligations bestowed on them when they are appointed including keeping accounting records and filing accounts. Of course the shareholder and director can be one and the same person as is often the case in an owner managed business.
The clear advantage of setting up a limited company and trading through such a business structure is the protection of limited liability; if the company fails the debts remain with the limited company and aren’t passed onto its directors unless there has been some wrongdoing.
What taxes will I pay?
Tax is paid on profits (income less allowable costs) from your business.
The business structure (sole trader or limited company) that you operate under will determine the taxes that are paid.
In the past the attraction of a limited company had been enhanced due to lower taxes on the profits extracted from the business. With the introduction of the Dividend Tax and the increases in Corporation Tax, this advantage has been eroded for many unless you have larger profits (at least over £30,000). If your profit is less than that, then operating as a sole trader might be the preferred route.
Sole Trader Taxes
Depending on profit levels a sole trader will pay:
- Class 2 National Insurance – a fixed weekly amount
- Class 4 National Insurance – a percentage based on profit over a threshold
- Income tax
Class 2 and 4 National Insurance is explained at https://www.gov.uk/self-employed-national-insurance-rates.
Income tax is explained at https://www.gov.uk/income-tax.
Limited Company Taxes
A limited company pays corporation tax on its profits.
Taxes on Dividends
It’s worth noting that dividends are paid out of distributable profits; basically profits after allowing for corporation tax.
Dividend Tax applies to any amounts taken out of the company. The current rates of dividend tax (tax year 2023 / 2024) are:
- First £1,000 of dividends – tax free
- 8.75 % for dividends falling within basic rate tax (caution on how this is calculated)
- 33.75% for dividends falling within higher rate tax (which will be over £46,350 from April 2018)
- 39.35% for dividends falling within the additional rate of tax with income over £100,000 meaning restrictions on your personal allowance
If either a sole trader or limited company employs anyone then they will, subject to conditions, have to run a payroll and pay PAYE. A director of a limited company can pay themselves a salary or wages, but a sole trader cannot. The directors of the limited company may need to account for any salary paid on their self assessment. If they are also a shareholder and in receipt of dividends, these need to go on to the self assessment as well.
When do I have to file accounts and returns?
It’s really important to keep on top of your deadlines and filing responsibilities. Generally HMRC, for limited companies, will write to you about your deadlines. Companies House no longer send paper reminders about your accounts and Confirmation Statement being due. You have to sign up for email reminders. Of course the correspondence will only reach you if you have told the authorities about any changes in your postal or email address or if you have mail forwarding when using a registered office service.
For limited companies the accounts will generally be due at Companies House 9 months after the year end. Special rules do apply in the first year with the accounts being due 9 months after the date of registration of the company. The corporation tax has to be paid 9 months and 1 day after the end of the year with the accounts and corporation tax return being filed with HMRC 12 months after the end of the year although in practice this is usually done at the same time as filing at Companies House.
If you are self employed as a sole trader you will need to file a self assessment by 31st January following the end of the tax year (31st October if you are filing a paper return). Tax is also due by 31st January and you may have to make a payment on account towards your tax bill for the current year. Payments on account are due on 31st January and 31st July.
Directors of a limited company may also need to file a self assessment if, for example, they have received dividends and need to pay additional tax.
What costs and expenses can I claim against tax?
Often it is obvious if the cost can be claimed by following what is known as the “wholly and exclusively” rule. Wholly and exclusively incurred for the purposes of the trade, profession or business is the tax term which is used by HMRC. It means that any costs should be incurred while attracting more customers or performing the tasks of the business. So things like stock, web site costs, hosting, advertising, stationery, software etc would usually all be allowable costs.
There are some exceptions to this straight forward rule which can trip you up. For example you cannot claim for clothing unless they are uniforms or protective clothing; HMRC say we need clothes for warmth and decency. Entertaining clients is also not an allowable cost for tax purposes; that’s just the rule. There are specific rules for claiming travel and subsistence costs; generally you have to be travelling for business and not just going to your usual place of work. If you work at home then you can claim for use of home as office which requires a calculation by reference to the amount of space you use in your home and the time that you use it for. If in doubt then the GOV.uk web site is a good place to check out the specific rules on what you can claim.
What if I pay for things out of my own bank account?
If you do pay for costs out of your own pocket then you can claim these back from your business. That said it is much easier to set up and pay all business costs from a separate business bank account. New Apps to the market, such as Coconut, allow you to open up a bank account online, store receipts against bank transactions and add in the bookkeeping making keeping up to date in your accounting much simpler.
Can I claim for a laptop?
Given their almost throw away nature, small items of equipment such as laptops, printers and tablets would generally not be treated any differently to other costs being recorded as equipment in your accounts. However if you spend money on large items of plant or equipment you would record the items as a capital cost, claim depreciation in the accounts then adjusting the profit to claim “capital allowances” on your tax return. Sounds complicated? Yes it can be and this might be an area where you would want to get help from an accountant to make sure you get things right.
Should I register for VAT?
Any business with a turnover over the VAT registration threshold must register for VAT. Under the threshold businesses can register voluntarily although it is worth stressing that careful consideration should be given to registration before you do it. Once registered for VAT the business claims back the VAT on its outlays (input tax). However the business must charge VAT on its sales (output tax).
The net of the two is paid over to HMRC if the output tax exceeds the input tax which is usually the case. A refund will be due if the business incurs more VAT than it collects.
Realistically this means that if you sell to non VAT registered businesses or consumers your price will be higher by the amount of the VAT, which could have a detrimental impact on your business when your prices are compared to the competition. So it’s worth thinking this through before you jump into VAT registration.
The VAT Flat Rate Scheme may be a viable alternative to look at although this has become less attractive with the Low Cost Trader Rules. Under the scheme the business must still charge VAT at 20% on all sales.
Being VAT registered does place an administrative burden on businesses through the quarterly reporting regime and businesses with turnovers over £85,000 will fall into Making Tax Digital for VAT.
Is there anything I can do to make keeping the books easier?
For the self-employed an optional scheme called Simplified Expenses exists aimed at making the recording of costs easier. This scheme can be used by sole traders and partnerships but not companies. The rules allow for a flat rate to be used for certain expenses rather than recording actual costs incurred.
The types of expenses covered by this scheme are:
- business costs for vehicles
- working from home
- living in your business premises
Full details of the rules can be found at https://www.gov.uk/simpler-income-tax-simplified-expenses.
My income is really small – do I still need to do accounts?
In April 2017, HMRC introduced the Trading Allowance. This allowance exempts the self-employed with a total annual gross trading income of £1,000 or less from registering for self assessment.
If self-employed income is over £1,000 then the amount can be offset against income rather than claiming all costs which can of course make bookkeeping simpler. Rules apply and full details are explained at https://www.gov.uk/guidance/tax-free-allowances-on-property-and-trading-income.
Do I need an accountant?
This is a question often asked by those starting out in business. Strictly speaking there is no requirement for you to engage an accountant although if numbers are not your thing or you are too busy running your business then you may want to use one. The benefits of having a good accountant on board are that they will ensure that you meet your deadlines and they will keep you up to date with tax changes as they happen. There will be no need to spend hours searching the internet for answers to tax and accounting questions. Forums, searches, articles and blogs can be great sources of information, but they are general and may just not be right for your specific needs.