If you start working for yourself, you must register with HM Revenue & Customs as soon as possible as self employment. Otherwise you may be liable to a penalty. If you start working for yourself you become liable for class 2 national insurance contributions and must notify HM Revenue & Customs by 31 January after the end of the tax year in which the self employment commenced. You may register online, by telephone or by using the form (CWF1) incorporated in leaflet SE1 (Are you thinking of working for yourself?).
What profits do HM Revenue & Customs 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 or motor vehicles, you will be entitled to deduct a proportion of the cost each year you own them and use them in your business. Claims for such capital expenditure are known as capital allowances.
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 HM Revenue & Customs allocate profit to tax years?
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 2012/13 could be based on accounts for a year ending on various dates ranging from 6 April 2012 to 5 April 2013. 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?
Tax returns
Tax returns covering income for the year ending 5 April 2012 are to be submitted to HMRevenue & Customs by 31 October 2012 for paper returns or 31 January 2013 for online returns. The return will include a self assessment of your liability to income tax and capital gains tax.
There are automatic penalties for late filing of tax returns.
Payments on account of income tax and Class 4 NIC will be due on 31 January and 31 July. These interim payments will be based on one half of the total liability (less any tax deducted at source). You will have the right to reduce payments on account if you believe the income tax for the current year is less than the previous year.
The balance of income tax for 2011/12 is due on 31 January 2013 (along with the first interim payment for 2012/13 and any capital gains tax for 2011/12).
What about the complications?
Opening years
In the first tax year of your business, the tax payable is based on the profit arising between the starting date and the following 5 April. This is taken as the appropriate fraction of the profit shown in your first set of accounts. Say you start on 1 June 2012 and your first accounts run to 30 June 2013 with a profit of £13,000, then tax will be worked out (to the nearest month) on the profits of the following periods:
2012/13 1 June 2012 to 5 April 2013 – 10/13 x £13,000 i.e. £10,000
2013/14 1 July 2012 to 30 June 2013 – 12/13 x £13,000 i.e. £12,000
You can see that the profit from 1 July 2012 to 5 April 2013 (9 months) has been taxed twice. The ‘overlap’ profit of £9,000 will be available for deduction when the business comes to an end, or (at least in part) if you change your accounting date to one nearer 5 April.
What about national insurance?
The self-employed are subject to a two-tier system of national insurance contributions.Class 2 contributions are at a flat rate of £2.65 per week, payable against a quarterly bill or by direct debit from your bank account, if earnings exceed £5,595 per annum.
Profits between £7,605 and £42,475 are subject to Class 4 contributions at a rate of 9%. Profits in excess of £42,475 are liable to Class 4 contributions at the rate of 2% without any upper limit. Class 4 contributions are collected by HM Revenue & Customs and are payable at the same time as the instalments of income tax.
If you do not register your liability to class 2 National Insurance your liability will be up to a maximum of 100% of the lost contributions for a deliberate failure; concealed failure 70% and all other cases the penalty is 30%. There will be no penalty if there is a reasonable excuse for the failure to notify.
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 HMRevenue & Customs, and is not deductible from business profits.
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