Want to be self-employed in the UK? Here is a basic tax guide to get you started

We have created this basic UK tax guide for the benefit of self-employed individuals. However, if you find yourself in a more complex tax situation, we recommend seeking the assistance of an accountant to ensure that you receive tailored advice. They can help you navigate the intricacies of the tax system and guide you toward making informed decisions that are best for your business.

Being self-employed and tax

If you are self-employed in the UK, you have to pay taxes on your income after allowable expenses. This can be a daunting task, especially if you are new to running your own business. In this blog post, we will explain everything you need to know about being self-employed in the UK and how to file your tax returns correctly and on time.

What is self-employment?

Self-employment (also known as sole trader) means that you work for yourself and not for an employer. In most cases, if you work for yourself and you have not formed a limited company to carry-on the business, you are self-employed.  You are self-employed if:

• You run your own business and have control over how and when you work.
• You have more than one client or customer.
• You can hire other people to help you with your work.
• You are responsible for the success or failure of your business.
• You can decide how much to charge for your services or products.

You are not self-employed if:

• You work under a contract of employment and have an employer who tells you what to do and when to do it.
• You only work for one client or customer and they can end your work at any time.
• You do not have any control over how and when you work.
• You are paid a fixed amount for your work.
• You cannot hire other people to help you with your work.

Badges of trade:

If you sell goods, HMRC will use a set of criteria called the Badges of trade to determine whether your selling activities is a trading activity or not. If it is not a trade, then making gains by selling items would be taxed under Capital Gains tax instead. 

They are based on previous case law and common sense principles. If an activity is a trading activity, it is subject to Income Tax and National Insurance, rather than Capital Gains tax.

The nine badges of trade are:

• Profit-seeking motive: An intention to make a profit supports trading, but by itself is not conclusive.
• The number of transactions: Systematic and repeated transactions will support trading .
• The nature of the asset: Is the asset of such a type or amount that it can only be turned to advantage by a sale? Or did it yield an income or give ‘pride of possession’, for example, a picture for personal enjoyment?
• Existence of similar trading transactions or interests: Transactions that are similar to those of an existing trade may themselves be trading.
• Changes to the asset: Was the asset repaired, modified or improved to make it more easily saleable or saleable at a greater profit?
• The way the sale was carried out: Was the asset sold in a way that was typical of trading organisations? Alternatively, did it have to be sold to raise cash for an emergency?
• The source of finance: Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset?
• Interval of time between purchase and sale: Assets that are the subject of trade will normally, but not always, be sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading. However, an asset, which is to be held indefinitely, is much less likely to be a subject of trade.
• Method of acquisition: An asset that is acquired by inheritance, or as a gift, is less likely to be the subject of trade. 

These badges will not be present in every case and some may point one way and some the other. The presence or absence of a particular badge is unlikely, by itself, to provide a conclusive answer to the question of whether or not there is a trade. The weight to be attached to each badge will depend on the precise circumstances. The approach by the courts in using the badges of trade has been to decide questions of trade on the basis of the overall impression gained from a review of all the badges.

How to register as self-employed?

If you are self-employed, you have to register with HM Revenue and Customs (HMRC) as soon as possible after you start your business. You can do this online or by phone. You will need to provide some personal and business details, such as:

• Your name, address and date of birth
• Your National Insurance number
• The name and nature of your business
• The date you started your business
• Your contact details

Once you are registered, you will receive a Unique Taxpayer Reference (UTR) number, which you will need to file your tax returns. You will also need to set up a Government Gateway account, which will allow you to access online services from HMRC.

How to keep records of your income and expenses?

As a self-employed person, you have to keep records of all your income and expenses related to your business. This will help you calculate how much tax you owe and claim any reliefs or allowances that you are entitled to. You should keep records of:

• All your sales and takings.
• All your purchases and expenses.
• Any personal money that you put into or take out of your business.
• Any other income that you receive, such as interest, dividends or rent.
• Any assets that you buy or sell for your business, such as equipment or vehicles.

You should keep your records for at least five years after the deadline for filing your tax return. You can keep them in paper or digital format, as long as they are accurate and complete. You should also keep any receipts, invoices, bank statements or other documents that support your records.

How to file your tax return?

If you are self-employed, you have to file a Self Assessment tax return every year by 31 January following the end of the tax year (the 5th of April). If your make less than £1000 during the tax year, the trading allowance will cover it, meaning you won't have to pay any tax. In such cases, you are not required to file a Self Assessment or report to HMRC. Check if you need to send a Self Assessment tax return here.

The tax year runs from 6 April to 5 April. For example, if you started your business in June 2023, you will have to file your first tax return by 31 January 2025 for the tax year ending on 5th of April 2024.

You need to register for Self Assessment by 5 October following the end of the tax year you need to send a tax return for. which is a system for reporting and paying your income tax and NICs to HM Revenue and Customs (HMRC).

You can file your tax return online or by post using form SA100. You will also need to fill in some supplementary pages depending on the type of income that you have. For example, if you are self-employed, you will need to fill in form SA103S (if your annual turnover is less than £85,000) or form SA103F (if your annual turnover is more than £85,000).

Keep track of income and expenses

You will need to report all your income and expenses from your business on your tax return. If you have a large amount of transactions, you may find it easier to use an app to help you keep track of all the spending. You can deduct some expenses from your income to reduce your taxable profit, such as:

• The cost of goods that you sell or use in your business.
• The cost of maintaining your business premises, such as rent, rates, utilities and insurance.
• The cost of travel for business purposes, such as fuel, parking and public transport fares.
• The cost of advertising and marketing, such as website fees, flyers and social media.
• The cost of professional fees and subscriptions, such as accountancy, legal and trade association fees.
• The cost of equipment and tools that you use in your business, such as computers, phones and software.
• The cost of training and education that is relevant to the business, such as courses, books and seminars.

You cannot deduct some expenses from your income, such as:

• The cost of personal or private use of your business premises, equipment or vehicles.
• The cost of clothing that is not a uniform or protective clothing.
• The cost of entertainment, such as meals, drinks or gifts for clients or customers.
• The cost of fines, penalties or interest for late payment of taxes or other debts.

You can also claim some reliefs and allowances that can reduce your tax bill, such as:

• The personal allowance, which is the amount of income that you can earn tax-free. For the tax year 2023/24, the personal allowance is £12,570.
• The trading allowance, which is a flat rate deduction of £1,000 that you can claim if your annual turnover is less than £1,000. This means that you do not have to report your income or expenses if you qualify for this allowance. 
• Trading allowance partial relief: Another way to use the trading allowance is if your annual income is more than £1000 but your expenses is low, in this case you can claim the £1000 trading allowance as a flat rate deduction instead of deducting your business expenses and other allowances from income to workout your taxable amount. (although this means that you lose other allowances such as mortgage interest as a tax reducer, rent-a-room scheme allowance, and the ability to deduct pre-trading expense).
• The property allowance, which is a flat rate deduction of £1,000 that you can claim if you have income from property, such as rent or royalties. This means that you do not have to report your income or expenses if you qualify for this allowance.
• The marriage allowance, which is a transfer of 10% of your personal allowance to your spouse or civil partner if they earn less than you and are a basic rate taxpayer. This can save you up to £252 in tax for the tax year 2023/24.
• The capital allowances, which are deductions for the cost of buying or improving assets that you use in your business, such as machinery, vehicles or furniture. You can claim different types of capital allowances depending on the type and value of the asset. Note: you cannot claim capital allowances if you use cash basis, except for on cars. 

If you’re a sole trader or partnership and have an income of £150,000 or less a year, you may be able to use a simpler system called cash basis instead.

How to pay your tax?

If you are self-employed (with tax over £1000 and you pay less than 80% of your tax through payroll as an employee), you have to pay your tax in two instalments: one by 31 January (this will be the tax you owe plus 50% for next year) and another 50% for next year by 31 July. These are called payments on account and are based on your previous year's tax bill. This is so that the amount you pay is more spread out throughout the tax year, and you don't end up with a massive tax bill all at once. For example, if you owe £2,000 in tax for the tax year 2023/24, in addition to paying your tax, you will have to pay 50% (i.e. £1,000) for the following year in advance by 31 January 2025, and another £1,000 by 31 July 2025.

You also have to pay a balancing payment by 31 January following the end of the tax year. This is the difference between your actual tax bill and the payments on account (which were only estimates) that you have made. For example, if you owe £2,200 in tax for the tax year 2023/24, you will have to pay £200 by 31 January 2026.

You can pay your tax online or by phone using a debit or credit card, direct debit or bank transfer. You can also pay by cheque or cash at a bank or post office. You should always quote your UTR number when making a payment.

National Insurance(s)

If you are self-employed in the UK, you need to pay National Insurance contributions (NICs) to qualify for certain benefits and the State Pension. There are two types of NICs that you may have to pay: Class 2 and Class 4 .

Class 2 NICs are a flat rate of £3.45 a week for the tax year 2023 to 2024, if your profits are at least £6,725 a year. You can choose to pay Class 2 NICs voluntarily if your profits are below this threshold, or if you are exempt from paying them for some reason.

Class 4 NICs are based on your profits and are charged at two rates: 9% on profits between £12,570 and £50,270, and 2% on profits over £50,270 for the tax year 2023 to 2024. You pay Class 4 NICs through your Self Assessment tax return.

You can pay both Class 2 and Class 4 NICs through Self Assessment. Note that if you need to make payment on account to HMRC, this amount will includes Class 4 NIC in the calculation.  

What are the penalties for late filing or payment?

If you file your tax return or pay your tax late, you may face penalties and interest charges from HMRC. These include:

File tax return late:

• A £100 penalty if you file your tax return more than three months late.
• A daily penalty of £10 for each day that your tax return is more than three months late, up to a maximum of £900.
• A further penalty of 5% of the tax due or £300 (whichever is greater) if you file your tax return more than six months late.
• Another penalty of 5% of the tax due or £300 (whichever is greater) if you file your tax return more than 12 months late.

Pay your tax late:

• A penalty of 5% of the tax due if you pay your tax more than 30 days late.
• Another penalty of 5% of the tax due if you pay your tax more than six months late.
• A further penalty of 5% of the tax due if you pay your tax more than 12 months late.
• Interest on the unpaid tax from the due date until the date of payment.

You can appeal against a penalty or interest charge if you have a reasonable excuse for filing or paying late, such as:

• A serious illness or bereavement.
• A fire, flood or theft that affected your records.
• A technical problem with HMRC's online service.
• A postal delay that was out of your control.

You should contact HMRC as soon as possible if you have a reasonable excuse and provide evidence to support your claim.

In Summary

While being self-employed can be rewarding, it's crucial to have a good understanding of the fundamentals of tax affairs to avoid any issues. There are numerous resources available online if you want to learn more. As you become more familiar with the processes, you'll find that it's not as overwhelming as it may seem at first. If you encounter any difficulties, your local Chamber of Commerce can often provide reliable tax advice if you join their membership, or you may wish to consult an accountant.

If you own a SME and you are looking for an accounting software, we would recommend using Xero. Get a free trial or get 50% off for 3 month with this link.

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