As a self employed small business owner, one of the most daunting things you need to get your head around is tax & accounts. Even if you’ve got an accountant you still need to have a good handle on what’s going on. You need to know roughly how much to set aside for the tax man. Don’t panic! Let’s take a look at tax for the self employed in the UK.
This is a pretty old video and things have moved on a bit since this was filmed, but you might still find some useful information in it. Or just read the article below:
Do I need an accountant?
Let’s cover off the most essential point. If you’ve never done your own tax & accounts and don’t know where to start, which is probably why you’re on this site, then yes -- you absolutely need an accountant! I’m not an accountant and you shouldn’t be making important business decisions based on the ramblings of a random bloke on the internet.
An accountant will generally save you more than they cost and can help structure your business affairs in the most efficient manner possible. Over time they’ll become intimately aware of your finances and this knowledge is invaluable. Having said all that, as a business owner the responsibility for EVERYTHING is on YOUR HEAD. It’s no use telling HMRC “But my accountant said…” ’cause it won’t wash. When you run your own business you need to have at least a vague handle on what’s going on. So here goes.
Let’s start with a quick summary
- The UK tax year for self employment runs from 6th April to the following 5th April
- You need to register with the UK government (HMRC) to tell them that you’re self employed
- Every year you need to complete a Self Assessment tax return online and pay any tax and National Insurance due
- When you complete a tax return, you have the option of being on Cash Basis or Traditional Accounting -- I’m assuming you’ll be on cash basis
- Normally your tax return and tax bill is due by 31st January absolute latest -- so you’ve got nearly 10 months from the end of the tax year to pull your finger out
- Tax is paid on 20% of your profits (not turnover)
- National Insurance is paid on 9% of your profits (not turnover)
- There are various thresholds before the above kicks in
- At the time of writing you get a £12,500 tax free allowance
- You also get a £1,000 self employment tax free trading allowance
- Being self employed is NOT the same as running a limited company -- this article has nothing to do with limited companies
- You can have as many self employed businesses as you like (within reason)
Do I need to send HMRC my accounts and receipts?
No! HMRC don’t want anything like that. Everything is done on trust on the basis that if you abuse the trust you’ll go to prison. Don’t panic! Everyone makes mistakes. HMRC are generally only heavy handed if you’re blatantly cheating the system. If you get audited and a mistake is found you’re normally just asked to pay the difference due -- or it might even work in your favour and HMRC will give you some cash! When it comes to your tax return, generally speaking the only two figures you need to provide are:
- Total turnover
- Total business expenses
Tax is paid on Profits NOT Turnover
Sometimes I hear non-self-employed folk bleating on about how it’s not fair that we only have to pay tax on profits. But that’s normal. It applies to everyone, including the folk bleating on. If that wasn’t the case you’d have to bring your own desk to work. So stop saying such ridiculous things.
For all the sane people in the world, yes -- you pay tax on profits, not turnover. That’s because turnover doesn’t tell you anything about how much ‘new money’ a business has actually made. You can’t know that information without knowing the running costs of the business. In it’s most simple form, if you bought 100 T-shirts for £10 each and sold them for £10 each then you’ve made £0. You’re no better off than if you’d sold zero T-shirts. Or just sat and watched TV for a while. In it’s most simplistic form:
PROFIT = TURNOVER minus BUSINESS EXPENSES
What are business expenses?
- Cost of Goods Sold
- Premises Rental
- Using Home as an Office
- Vehicle Running Costs
- And many other things!
Essentially anything that’s a fundamental requirement for your business to function is regarded as a business expense. Read this HMRC article for more information.
The most obvious cost you’ll have is the cost of the stuff that you’ve sold. Sometimes this gets referred to as COGS (Cost of Goods Sold). So if you take your turnover and deduct how much you paid for goods, that gets referred to as your GROSS PROFIT. You didn’t really need to know that, but it’s basic business terminology.
GROSS PROFIT = TURNOVER minus COST OF GOODS SOLD
But obviously that doesn’t tell you the whole story. Your business will have running costs. These running costs can be quite substantial and must be taken in to account to work out your taxable profit. So for example, postage, vehicle costs, premises etc.
NET PROFIT = GROSS PROFIT minus RUNNING COSTS
The net profit is generally regarded as your taxable profit. Let’s look at a very simplistic example. Let’s say you had:
- £30,000 turnover
- £5,000 cost of goods
- £5,000 running costs
We’ll assume you’re using the cash basis and bundle the two lots of £5,000 together for simplicity. So that’s £10,000 business expenses. As such you made £20,000 taxable profit (£30,000 -- £10,000). Remember you have a £12,500 tax-free allowance (in the 2019/20 tax year). So £20,000 minus £12,500 personal allowance = £7,500 taxable income. At a 20% tax rate that would be £1,500 tax due (£7,500 x 20%). This is very simplistic, makes lots of assumptions and doesn’t cater for National Insurance (NI). But hopefully you get the general idea.
What are simplified expenses?
Working out the true running costs of a vehicle along with using your home as an office can be quite complex. As such, HMRC have a scheme known as ‘simplified expenses‘. Instead of using actual running costs for these things, you essentially use a flat rate of:
Most people I know use the simplified expenses for their vehicle but DON’T use the simplified expenses for working. The £26/month generally doesn’t come close to covering the actual costs of working from home. Obviously this depends on your individual situation though.
Using the simplified scheme for working from home, this allows a maximum of £312 per year. Whereas more realistic actual costs might be closer to:
- Utilities: £2,000
- Council Tax: £2,000
- Rent: £6,000
- Insurance: £500
- Telephone: £300
- TOTAL: £10,800
You need to work out a fair proportion to claim. Let’s say you have 4 rooms in your house and use 1 as an office for 5 days a week. So you could say your costs for working from home are £10,800 x 25% x 5/7 = £1,929. Compare this to the £312 HMRC are offering and you can see they’re well out of touch with modern living costs. The 45p per mile tends to work for now though so it’s worth making use of that for the hassle factor alone.
Remember, if you’re claiming the 45p per mile (and that’s only for your first 10,000 miles) then you CAN’T also claim for fuel costs, vehicle repair etc. The whole point of simplified expenses is that you DON’T need to keep track of these things. The main exception to this is car parking and public transport, which you can claim for separately.
Phew, that was a very long winded way of telling you to claim 45p per mile for vehicle costs. How does that work? Let’s say you did 1,000 business miles in the tax year, so that’s £450. Just add £450 to your business expenses figure mentioned above. So your total business expenses are now £10,450. Simple.
Record keeping for mileage claims?
OK, this is a big one. If you’re using the simplified expenses scheme and claim 45p per mile for business travel you MUST keep records of EVERY business journey. You can do this in a spreadsheet or using good old fashioned pen and paper. This is what I log and HMRC have been fine with it:
- Date of travel
- Miles travelled
- Start address (normally your house)
- End address
- Purpose of the trip
- Amount claimed (normally distance x 45p)
AND don’t forget to claim for EVERY business journey! So not just client related travel but also:
- Driving to the garage to get fuel
- Driving to suppliers
- Driving to the post office
- Driving to the bank
- Driving to training courses
- Driving to business trade shows
If the travel was in any way business related you should be logging it and claiming for it. It all adds up!
A quick note on Opex and Capex
You might have heard these terms used and don’t know what they are. Don’t panic about Opex and Capex. Capex is equipment. Opex is not equipment. Now that cash basis is widely used we no longer need to worry about opex and capex as much. Everything is bundled together. BUT just so you know:
Opex = Operational Expense
Operational expenditure is everything to do with the general day-to-day running of your business. So premises rental, telephone costs, postage, stationery etc. Most accountants I know use the rule of thumb, is it likely to last longer than a year? If so (like a printer) it’s a capital expense. If not (like paper) it an operational expense.
Capex = Capital Expense
Capital expenditure refers more to equipment -- BIG purchases that are likely to last the business for several years. Things like heavy industrial equipment, printers, computers, furniture and the like. In the world of Self Assessment tax this gets referred to as the Annual Investment Allowance or AIA and if you’re not using cash basis you would enter this as a separate figure in your tax return. There are separate rules for how this is handled. We’re keeping things simple for now though and assuming you’re on cash basis, so don’t worry about it. It all gets bundled in to your business expenses.
What about stock?
If you’re using the cash basis, again it’s all bundled together with your running costs. In other words you’d completely bypass working out Gross Profit and just jump straight to Net Profit (Taxable Profit). If you carry a lot of stock you definitely need to speak to an accountant to work out the best way of working out your tax liability.
What about record keeping?
This article is getting very long, so we’ll delve in to this in a bit more detail at some other time. You need to keep a log of EVERYTHING related to your business. That’s a full income log and a full expenses log (plus mileage log). You need to keep original receipts for everything you want to claim as an expense. You can apparently keep electronic copies of receipts… providing you don’t have a Tax Credits audit. This is what I log in a simple spreadsheet:
- Customer name
- Customer address
- Customer phone & e-mail
- Date invoiced
- Date paid
- Amount paid
- Payment method
- Brief description of job
- Receipt Id. (write this on the physical receipt)
- Supplier name
- Payment date
- Amount paid
- Item purchased
- Brief description
- Category (stationery, postage, customer materials etc.)
You can download an Excel template I use for logging the above from my Patreon. I’d love to be kept up to date with progress of your self employed journey! Keep in touch over on Twitter @smallbusinesstb -- best of luck!
PLEASE REMEMBER: I’m not an accountant and you should ALWAYS seek advice from a trained professional. I have however survived several HMRC audits so I’m assuming what I’m saying is vaguely correct. Don’t come running to me if HMRC disagree with anything I’ve said. But do let me know if you’ve spotted any mistakes!