What are the Tax Implications of Becoming Self Employed?Written on July 22, 2015 by Kirk Rice LLP
Taxing Times QuestionsThe Question:
I have always been employed, but I am now considering becoming self-employed and starting my own business. How will my income be taxed and when do I pay it?
Kirk Rice LLP answers:
The system for taxing the self-employed is radically different from that for employees and company directors. The main distinctions are as follows.
Basis of assessment
Generally, employees are taxed on income received during a tax year. The self-employed are assessed on the profits of the accounting period, which ends in the tax year, with special provisions for the opening and closing years of businesses. Profits are calculated as the income receivable, less expenses incurred. It is important to carefully consider the accounting year end date as there may be opportunities to defer tax. The year end date does not have to be the same as the tax year (year to 5 April).
Deduction of expenses
For employees, the test is whether the expense was laid out ‘wholly, exclusively and necessarily in the performance of the duties of the employment’. This harsh test contrasts with that for the self-employed, whose expenses need only be laid out ‘wholly and exclusively for the purposes of the trade’.
There will nearly always be expenditure, that is partly business and partly private, such as motoring; with the increase of working from home, council tax and fuel bills will also need to be apportioned (although where office use of home expenses are claimed some care must be taken as to not trigger a tax charge on the sale of your home at a later date).
Payment of tax
Employees will not normally have to make payments on account of income tax unless they have substantial untaxed income. They do, however, pay tax and National Insurance contributions as they receive their income under the PAYE system. The self-employed pay at least some of their tax and National Insurance contributions in arrears, generating a cash flow advantage.
Those setting up in business on their own account should have regard to the following:
Tax is due twice per year on 31 January and 31 July. The 31 January tax payment can be quite high, particularly where a business has rising profits year on year. Problems can also arise where the business has fluctuating profits. It is therefore important to plan quite carefully and consider making claims to reduce payments on account where profits are reducing.
Tax Return
The mechanism for communicating your business profits to HMRC is via the annual tax return. This return will include all your personal income and not just the profits from your business. The final deadline for submitting your tax return is 31 January following the end of the tax year. Once you start your business you should register with HMRC straight away, they will then send you a notice to complete a tax return at the appropriate time.
If you would like more advice regarding this issue or any other tax matter, please contact us.
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Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made.
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