What are financial accounts?
Why would I need an accountant?
What is Self Employment?
What do I need to do if I become self employed?
What tax do I pay if I am self employed?
When do I have to file my tax return by?
What is the best way to claim motoring expenses?
What is National Insurance and do I have to pay it?
How do I pay the self-assessment tax?
What penalties are there if I file my tax return late?
What are self-assessment payments on account?
What is VAT?
When do I have to register for VAT?
Why might registering for VAT be to my advantage?
VAT - what is the difference between cash accounting and invoice-basis?
What are VAT inputs and outputs?
What are the current tax rates?
What are financial accounts?
Financial accounts are a statement of how much money a business has made in a given period (usually a year).
There are various types:-
Why would I need an accountant?
There could be many reasons, but the main one is usually tax. If you are self employed, a company director, or have untaxed income you will need to file a tax return with H.M. Revenue & Customs, and pay any tax due.
The tax laws are complex, and you may need accounts prepared to show your taxable profit. Whilst you may be able to deal with this yourself, for people who are self employed it is usually safer and less stressful to use a professional accountant.
What is Self Employment?
Self employment is when you work for yourself.
Typically a self employed person will:-
- Decide for themselves how and when to do the work.
- Take financial risk.
- Take responsibility if the work in not done correctly.
- Provide their own tools and equipment.
Generally it will be fairly obvious if you are self employed, but in some cases it is less clear cut. There is no clear divide between being self employed or an employees, and for tax purposes it depends on a number of 'indicators'. If in doubt try using the H.M. Revenue & Customs' Employment Status Indicator at www.hmrc.gov.uk/calcs/esi.htm.
The question is most important when you employ someone to work for you. If you treat them as an employee, you will probably have to operate PAYE, provide paid holidays, and comply with a great deal of employment legislation. If you treat them as self employed, none of that applies. The snag is that if you treat a person as self employed, and H.M. Revenue & Customs later decide that they were really an employee of yours, then you could end up having to pay the tax that would otherwise have been deducted under the PAYE system plus employers National Insurance. Worse still, HMRC can treat the amount paid as the net of tax payment, and demand the tax due on the grossed up payment. So it can be important to get it right. H.M. Revenue & Customs are generally keen to have people treated as employees as they collect more National Insurance that way.
What do I need to do if I become self employed?
This is a complex situation, so probably the best thing would be to speak to an accountant straight away. Amongst other things, you will need to:-
- Inform H.M. Revenue & Customs that you have become self employed. They have a special form for this, a form CWF1 'Becoming self employed & registering for National Insurance'. This needs to be done within 13 weeks to avoid a penalty.
- Decide what business style to use - sole trader, partnership, limited company, limited liability partnership.
- Start keeping business books and records.
- Decide whether to register for VAT.
- If taking on employees, start operating PAYE.
- Make a list of business assets owed on commencement, and note their cost or reasonable second hand value. This is because such items will not normally appear in the books and records as you already have them, but tax relief can still be claimed on them. This could include items such as a computer, mobile phone, tools and equipment, or your vehicle.
- It is usually a good idea to open a business bank account, but this is not essential, especially if you are running a very small business for which a balance sheet will not be required.
- Consider claiming Working Tax Credit, Child Tax Credit, and class 2 National Insurance small earnings exemption, in case profits in the initial period of trading are low. These claims can only be backdated some 13 weeks, so if you wait until you know what your profits are, you could lose some of the benefit.
- Consider taking out business insurance, such as public liability insurance. Some public liability insurance policies also include cover for professional fees incurred if H.M. Revenue & Customs make formal enquiries into the accuracy of your tax return, and this is worth having if available.
- Consider taking out personal insurance in case you are unable to work because of sickness, or accident. No tax relief is available for this type of insurance, and it can be expensive and offer only very limited cover.
What tax do I pay if I am self employed?
Self employed people pay tax on their taxable business profits. Basically this is the income earned, less the related expenses.
Each year in April H.M. Revenue & Customs will send you a tax return, or a notice requiring you to complete one.
All taxable income of the tax year to 5th April needs to be shown on the tax return, and any relevant tax allowances claimed. This could include income from self employment, employment, rental income, bank interest, share dividends, pensions, capital gains, etc.
Your tax and class 4 National Insurance liability will then be calculated for the tax year, and any tax already paid will be deducted, such as PAYE tax on an employment or a pension, or tax deducted at source for investment income. Leaving a net amount payable.
This will fall due for payment the following 31st January.
If the amount due exceeds £1,000 you may also need to make payments on account towards the following year's tax liability.
When do I have to file my tax return by?
Tax returns issued in April, need to be filed with H.M. Revenue & Customs by 31st October following, if filed on paper. The deadline for on-line filing over the internet is the following 31st January.
So the last possible date for filing a tax return issued in April 2011 will be 31st January 2012.
If a tax return is issued at a later date you have at least three months to complete and file it.
What is the best way to claim motoring expenses?
Some self-employed taxpayers can claim motoring expenses on the basis of how many business miles they drive, rather than the actual costs involved.
Under this system a clear record of business journeys must be maintained. These journeys can then be claimed as a tax allowable expense in the accounts of the business, at the rate of 45p a mile for the first 10,000 miles, and 25p a mile thereafter. So for example 8,000 business miles would result in a claim for £3,600 worth of motoring expenses. You would need to maintain a log of all business journeys, showing the date the journey was undertaken, where to or some reasonable explanation for the journey, and the distance driven.
The alternative is to keep detailed records of the actual motoring costs such as fuel, repair costs, road tax and insurance. These expenses can then be claimed against profits, but only to the extent that they represent business use of the vehicle. H.M. Revenue & Customs expect taxpayers to keep a log of their motoring so that an accurate split can be made between business and personal motoring. Without such a log, there is a risk that H.M. Revenue & Customs could challenging the business proportion of the motoring expenses claimed in the accounts.
When using the mileage basis, no additional claim can be made for the general depreciation of the vehicle over time, as this is considered to be included in the 45p a mile, but additional costs for parking, bridge and ferry tolls can be claimed.
To use the mileage basis, your turnover must be below the VAT registration limit (currently £73,000 a year), and the basis must be used consistently from year to year. You can only change between the two systems when a vehicle is replaced.
Which is most advantageous in tax terms depends largely on how expensive your vehicle is to run, and the level of business motoring. However, the mileage basis will usually be simpler to operate in terms of bookkeeping, and can be used even if the vehicle used is not your own.
What is National Insurance and do I have to pay it?
National Insurance is a form of taxation. In theory it is used to pay for a range of state benefits. It is a system that is currently being reviewed by the government, but at present there are four types of NI:-
- Class 1 - paid by employees and employers.
- Class 2 - paid by the self employed, normally at a weekly rate of £2.50.
- Class 3 - voluntary contributions, usually paid to protect benefits if no other types of NI are being paid.
- Class 4 - paid by the self employed on taxable profits above £7,225 at a rate of 9%, and above £42,475 at a rate of 2%
So for the self employed there are two types of NI payable, class 2 & 4. Despite this the amount payable is generally less that that payable by employees. Having said that the self employed are entitled to less benefits.
From April 2011 both class 2 and class 4 NI is payable on 31st January and 31st July with the general self assessment tax liability. Payment of class 2 NI had previously been payable by monthly direct debits or quarterly bills.
If earnings from self employment are low, it is possible to apply for an exception from paying class 2 NI. The annual earnings limit for the exception is currently £5,315. This can be particularly useful for people in employment who also have small amounts of self employed income. As employees they are probably already paying class 1 NI, so paying class 2 NI would provide no additional advantage as regards state benefit entitlements. Exception applications can only be backdated 13 weeks, so if you expect to be below the income limit, it is important to apply early.
National Insurance is not payable after normal retirement age.
How do I pay self-assessment tax?
For those on the Self Assessment system such as the self employed, and people with untaxed income (such as rental income). Tax and National Insurance usually falls due for payment on 31st January or 31st July each year.
You will normally be sent a 'Self Assessment - Statement of Account' shortly before the tax falls due, which will show the amount payable, and give details of the different methods of payment.
If you don't receive a 'Statement of Account' (or it is inaccurate), it is still important to make the correct payment by the due date, as H.M. Revenue & Customs will charge interest and possibly penalties if you don't.
The 'Statement of Account' will include a payslip that shows your tax references. It is important to use the actual payslip, or at least the references shown on it, or H.M. Revenue & Customs may not be able to match the payment to you. If you have mislaid, a 'Statement of Account' use the payslip from a previous Statement.
Payment can be made by post, enclosing a cheque made payable to 'HM REVENUE & CUSTOMS ONLY followed by the payslip reference. Send it with the payslip to the address in the envelope provided, or alternatively to:-
HM Revenue & Customs
Accounts Office
Bradford
BD98 1YY
Payment can also be made at a Post Office, by giving them the payslip and a cheque made payable to 'POST OFFICE LTD'. The Post Office will also accept payment by debit card.
Payment can be made by Internet or telephone. Do not use the bank account details shown on the payslip which are only for payment by Bank Giro or at a Post Office. Instead use:-
Shipley: Sort Code 083210, Account number 12001020, Account name HMRC Shipley
or
Cumbernauld: Sort code 083210, Account number 12001039, Account name HMRC Cumbernauld
You will need your Self Assessment reference (UTR) which is a ten digit number shown on the payslip, followed by the letter K.
Payment can also be made by direct debit, or by debit or credit card using BillPay.
Further information can be found at www.hmrc.gov.uk/payinghmrc/selfassessment.htm.
What penalties are there if I file my tax return late?
The penalties have been increased this year and are now seriously high:-
| Length of Delay | Penalty |
|---|---|
| One day | £100 (even if no tax is payable) |
| Three months | £10 each day up to a maximum of £900 |
| Six months | £300 or 5% of the tax due, whichever is the higher |
| Twelve months | £300 or 5% of the tax due, whichever is the higher. In serious cases this can be increased to 100% of the tax due instead. |
These penalties also apply to each partner in a partnership.
The penalties for late payment are:-
| Length of Delay | Penalty |
|---|---|
| Thirty days | 5% of the tax unpaid at that date |
| Six months | A further 5% of the tax unpaid at that date |
| Twelve months | A further 5% of the tax unpaid at that date |
This is in addition to normal late payment interest.
H.M. Revenue & Customs can issue an estimate of what tax they think may be due, and calculate the interest and penalties on that sum. This estimate can then only be changed by sending in your tax return.
It is possible to appeal against these penalties, but the grounds for appeal are rather limited.
What are self-assessment payments on account?
If your self assessment tax and NI liability exceeds £1,000 you will normally be required to make payments on account towards the following year's tax liability.
For example if your liability for the 2010/11 tax year was £800, this would all fall due for payment on 31st January 2012. If the 2011/12 liability increased to £1,500 this would all fall due for payment on 31st January 2013, but because the amount due exceeded £1,000, payments on account towards the 2012/13 liability of £750 (50%) due 31st January 2013, with a further £750 (50%) due 31st July 2013, would be required.
If the actual 2012/13 liability was £1,800, £1,500 (£750 + £750) would already have been paid in January and July 2013 leaving a balance of £300 payable the following 31st January 2014. there would then be payments on account of £900 due 31 January and July 2014 towards the 2013/14 liability. Making £1,200 (£300 + £900) due 31st January 2014.
If on the other hand the actual 2012/13 liability had fallen to £1,200, £1,500 (£750 + £750) would already have been paid leaving an immediate tax refund due back of £300. Payments on account of £600 each would then fall due for payment in respect of the 2013/14 year on 31st January and July 2014.
This sounds very complicated, but you get used to it after a while. The payments on account do not increase the amount payable they just bring the payment date forward. However, this can cause cash flow problems when you first go on to the system, or if there are large fluctuations in profits from year to year.
It does have some advantages though. If profits are fairly steady from year to year, once you are on the system, it means the tax payments are spread more evenly between January and July, rather than all falling due in one go January. It also means payments are more up to date, so if for some reason you cease self employment, there will be less outstanding tax to pay.
What is VAT?
VAT stands for Value Added Tax. It is a tax imposed on the sale of goods and services.
VAT registered businesses charge VAT on the goods and services they sell. If they sell to another VAT registered business, that business can reclaim the VAT suffered on the goods or services they have purchased, but they will in turn have to charge VAT on their own sales. When sales are made to individual consumers or non-VAT registered businesses, the VAT cannot be reclaimed, and in effect the government gets the money.
There are currently three rates of VAT:
- Standard rate - 20%
- Reduced rate - 5%
- Zero rate - 0%
There are also some goods that are either:
- VAT exempt, or
- Outside the scope of VAT
Zero rated items include most foods (other than from restaurants or hot takeaways, and confectionery), children's clothing, public transport, and books and newspapers.
Reduced rate items include domestic fuels, such as coal and oil, and a few other bits and pieces such as children's car seats.
Standard rate applies to anything else that is sold by a VAT registered trader, unless it is VAT exempt or outside the scope of VAT.
When do I have to register for VAT?
If your business turnover (sales of goods and services) exceeds £73,000 in the twelve months to any month end, then you must register for VAT within the thirty days.
So for example you will need to check that your turnover does not exceed the turnover limit for the twelve months to 31st January, then the twelve months to 28th February, then the twelve months to 31st March, and so on.
If your turnover is approaching this figure it is a good idea to monitor the situation on a monthly basis, to ensure you do not exceed the limit without realising it, as there are penalties for late registration. Also you may end up having to pay VAT that could have been charged to your customers.
You should also register if you expect your turnover to exceed £73,000 in the next 30 days.
It is also possible to register for VAT voluntarily, see Why might registering for VAT be to my advantage? (below).
More detailed information about VAT registration can be found on the government's Business Links website at www.businesslink.gov.uk.
Why might registering for VAT be to my advantage?
Generally speaking VAT is a tax best avoided, but there are circumstances when VAT registration can work to your advantage.
If you are in business, but make only zero rated supplies. Which might apply say if you are a farmer or a fisherman, then you would normally have no VAT to pay on your sales, but you would be able to reclaim the VAT on your expenses. So registering for VAT would normally result in you receiving money from H.M. Revenue & Customs rather than having to pay it.
It may also be advantageous if all the work you do, is for other VAT registered businesses. This is because they do not care if you charge then VAT as they can reclaim it. So if you charge them £1,000, or £1,000 + VAT it makes no difference to them. This means you will be able to add the VAT on top of your normal prices, so though you will have to pay VAT to H.M. Revenue & Customs, it will be paid out of money you wouldn't otherwise have, so effectively there is no cost to you. The advantage being, that you can also reclaim VAT on your expenses.
VAT - what is the difference between cash accounting and invoice-basis?
Cash accounting is where you declare output VAT on your sales when the money is received from the customer, and claim input VAT on your purchases when payment is made to the supplier.
The invoice basis is where output VAT is declared when sales are invoiced (or possibly provided if earlier), and input VAT on purchases is claimed according to the date on the purchase invoice.
If your business turnover is below £1.35 million, you can chose to use the VAT cash accounting scheme. Larger businesses must use the invoice basis.
Cash accounting means simpler bookkeeping records can be kept, as there is no need to keep separate records of invoice dates. Also, if your customers are slow to pay, it means you are not having to pay VAT on the sale to H.M. Revenue & Customs before you have received the money from the customer yourself, which in turn saves problems with bad debt relief.
For most small businesses it is best to use the cash accounting basis, but this will depend on the nature of your business. For example if you are a farmer, with no output VAT to declare, the invoice basis could mean you are able to reclaim input VAT on your purchases earlier.
What are VAT inputs and outputs?
Input VAT is the VAT suffered on goods and services you purchase.
Output VAT is the VAT you charge on the goods and services you sell.
What are the current tax rates?
Current tax rates are always available on HM Revenue & Customs website. There you can find information on income tax, national insurance, corporation tax, capital gains tax, inheritance tax and stamp tax. For information on other taxes and allowances such as VAT, tax credits, child benefits and pensions please see the Rates & Allowances page of the same website.
Disclaimer
Please note that whilst every effort has been made to ensure that the information shown in the FAQ section is correct, it's accuracy cannot be guaranteed, and no responsibility can be taken for any errors or inaccuracy contained, or losses arising from any reliance placed on this information.
The information provided is not intended to be complete and definitive, and is provided to assist with personal understanding only.