Once you have become self-employed, the tax rules are quite different from those that may have applied when you were an employee. Instead of Income Tax and National Insurance being deducted from your earnings at source, you must be prepared to receive a bill at some time in the future. This can be a nasty shock if you haven’t put enough money aside. We aim to give you as much warning as possible of the likely timing and amount of tax payment due but it is not easy to do this during the first year of your new business or if you do not keep your records up to date.
What profit does the Inland Revenue tax?
The starting point for the calculation of taxable profits is your profit and loss account. In calculating taxable profits you are allowed 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. If you take stock for your own use, the disposal should be shown in the accounts at market value and not at original cost. It may be possible to avoid this by arguing that such items never actually formed part of your stock and by showing the original purchase price as private expenditure (drawings). Tax is payable on the entire 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 the work that is done.
How does the Inland Revenue allocate profit to tax years?
The aim of the system is that over the lifetime of your business the profits will be taxed in full, once, and once only. To make the system fair, there are certain complications you will have to cope with. The general rule is that the tax for a particular year is based on the profits of the twelve months to your accounting date in that tax year. For example, the tax for 2010/2011 could be based on accounts for a year ending on dates ranging from 6th April 2010 to 5th April 2011.
How is the tax collected?
Tax Returns covering income for the year ending 5th April 2011 have to be submitted to the Inland Revenue by 31st January 2012 (the ‘filing date’). The return will include a self-assessment of your liability to income tax and capital gains tax. If you don’t want to work out your own liability, you must send the tax return back to the Inland Revenue by 30th September 2011. There are penalties for late filing of tax returns.
Payment of tax on account of Income Tax and Class 4 NIC will be due on 31st January 2011 and 31st July 2011. These interim payments will be based on one half of the total liability (less any tax deducted at source) for 2009/2010. You will have the right to reduce payments on account if you believe the income for tax year 2010/2011 will be lower. The balance of income tax for 2010/2011 is due on 31st January 2012 (along with the first interim payment for 2011/2012 and any capital gains tax for 2010/2011). Interest and surcharges will be levied for late payment.
What about National Insurance?
The self-employed are subject to a two-tier system of National Insurance Contributions. Class 2 contributions are a flat rate per week, payable against a quarterly bill or by direct debit from your bank account, if earnings exceed the annual threshold. Profits in excess of the annual threshold are subject to Class 4 contributions at the current rate. Class 4 contributions are collected by the Inland Revenue and are payable at the same time as the installments of Income Tax.
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 the Inland Revenue, and is not deductible from business profits.
Please contact us if you would like help with your self-employed tax status.