The tax system for the self-employed

Registering with HMRC

If you start working for yourself as a sole trader (ie when starting self-employment), you must register with HMRC. You can do this at any time up to 5 October of your business’s second tax year. If you do not register you may be liable to a penalty, albeit as long as you register before the tax return become due, you should be fine.

You should ideally register with HMRC online. You can also register by telephone or by using the paper form (CWF1 - register if you are a self-employed trader) incorporated in leaflet SE1 (thinking of working for yourself?), if you are unable to do online.

Once you become self-employed, the tax rules are quite different from those that would have applied if you have previously been an employee. Instead of tax and national insurance being deducted from your earnings at source, you must be prepared to deduct and pay your tax up to twice yearly. This can be an unwelcome surprise 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 payments, 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, so be prepared to get your tax return as soon as the tax year has passsed.

What profits do HMRC tax?

The starting point for the calculation of taxable profits is your profit and loss account. In calculating your taxable profits you are entitled to claim deductions from your business income in respect of your allowable expenses incurred which have been incurred for the purposes of the trade (with a few minor exceptions). Claimed expenses must have been incurred on a ‘wholly and exclusively’ basis.

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. Claims for such capital expenditure are known as capital allowances so the tax treatment is different depending on the asset purchased.

Purchase of goods for resale, including things that make up part of your stock need to be accounted for differently and you cannot claim an immediate deduction for stock or goods still held as at your year-end. Also, if you take stock for your own use, the disposal should be shown in the accounts at market value, and not at original cost, hence there are some complexities to consider.

Tax is payable on the whole of the profits of a trade, and so payments for your own 'wages' (drawings) are not deductible. However, wages to others would be an allowable deduction, provided they are are reported to HMRC under a payroll scheme.

How does HMRC 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. But to make the system fair, there are certain complications you will have to cope with, such as the management of your advance payments on account. It may feel like you are paying your tax twice but your advance payments will always be towards the following year’s profits.

Generally you will be taxed year on the profits of the 12 months to your accounting date, being either 5 April or 31 March each year.

How is tax collected?

Tax returns covering income for the year ending 5 April should be submitted to HMRC by 31 January for returns filed online, (or by 31 October following the end of the tax year for paper returns). The tax return will include a self-assessment calculation of your liability to income tax (and any capital gains tax if applicable). It is usual practice to file a tax return online now.

If you don't want to work out your own liability and you are doing your tax return yourself on paper you should send the tax return to HMRC by 31 October, or file online by midnight on 30 December if you want HMRC to collect any tax you owe through your PAYE code if you also receive income subject to PAYE. You can ask for this if you owe less than £3,000. The final date for filing your tax return is midnight on 31 January following the end of the tax year. When filing online with HMRC’s software, your tax liability will automatically be calculated on completion of your tax return.

There are automatic penalties for late filing of tax returns, and currently this is an automatic £100 penalty for missing the 31 January deadline, with further penalties arising from £10 per day after three months.

Any PAYE income reported to HMRC should be shown on your Personal Tax Account via your government gateway account and this will also need to be included on your tax return. Your P60 or P45 will show your PAYE income.

Payment of tax

Payments on account of income tax and Class 4 NICs are due each year on 31 January and 31 July, for 50% of the total amount due at each payment date. These interim payments apply where the liability is over £1,000 and less than 80% of the liability is collected at source during the year. They are based on one half of the total income tax and Class 4 NIC liability of the previous tax year (less any tax deducted at source).

You will have the right to reduce payments on account if you know that the income tax for the next tax year is less than the previous year.

Interest and surcharges will be levied for late payment.

Payments on account inevitably catch the newly employed by surprise. If your liability meets the requirement of payments on account for the first time, you will be effectively paying 1.5 times your tax bill by 31 January and another half by 31 July of the same year.

National insurance

Self-employed profits are subject to national insurance contributions (NICs), known as Class 4 and Class 2 NIC (From 6/4/24 Class 2 NIC is not payable and now just deemed as paid subject to earnings levels). Your Class 4 NIC will be paid with the self-assessment tax liability.

Profits between the lower profits limit up to £50,270 are subject to Class 4 NICs at the current rate of 6%. Profits in excess of £50,270 are liable to Class 4 NICs at the rate of 2% without any upper limit. Class 4 NICs are collected by HMRC and are payable at the same time as the instalments and payment of income tax.

Save for your tax

It is essential to make proper provision to ensure the availability of funds to pay income tax and Class 4 NICs. Interest on unpaid tax is chargeable by HMRC, and is not deductible from business profits.