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Sole trader startup tax matters to consider (05/2022)

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Notification of commencement of trade

Notification of commencement of trade is required by 5 October following the end of the tax year in which the first day of trading falls.  There are penalties for failure to notify which can be accessed via:  https://www.gov.uk/log-in-file-self-assessment-tax-return/register-if-youre-self-employed

Note that commencement of trade is when the business is ready to accept its first customer.  At the latest, this would be when you start working for your first paying customer, but it could be earlier.

This notification means that the sole trader is then committed to submitting a tax return after the first tax year’s trading and all years thereafter.

Finally, if total income (ie before any costs) is less than £1,000, then there’s no tax payable and no need to submit a tax return.

 

Accounting period

Most sole traders adopt a 5 April year end which is the simplest approach and avoids having to allocate one year’s worth of results over two different tax years. 

Note that a tax year end of 31 March is treated in exactly the same way and is thus probably the best date to use.

Submitting accounts

Annually, a sole trader must submit a self-assessment tax return (SA100). This will show the net profit or loss after deducting all relevant and allowable costs from revenues which in turn determines the amount of tax and National Insurance due.

It is still possible to submit a paper copy of a tax return which has a deadline of seven months after the end of the accounting period (31/10/20xx for an accounting period ending 5/4/20xx or 31/3/20xx).

The alternative is to submit an electronic SA100 ten months after the end of the accounting period (ie typically 31/1/20xx+1).

Allowable expenditure – exclusively for business

The key rule is to identify which costs have been incurred exclusively for the purposed of running the business.  In this case they’re allowable and thus reduce both profits and the tax thereon. Examples include the following:

Sub-contractors or any staff (employed or used to run your business)
Business premises costs (rentals, insurance, maintenance and utility costs)
Consumables (raw materials for products created, stationery, protective clothing etc)
Advertising and marketing costs (telemarketing campaigns, google ads, website costs etc)
Financial costs  (bank fees, interest and insurance)
Training (eg external courses bought)
Indirect costs (fees for membership of network groups, subscriptions for business magazines or approved trade bodies)
Travel (mileage in your own car @£0.45pm upto 10,000 miles pa (thereafter £0.25pm), bus, train, taxi and parking and hotel costs for any business related activities – meetings, conferences, networking etc). Note travel from home to own office is not allowable
Business Assets – These are items which typically have an enduring benefit for the business over several years and include computers, printers and any equipment required to provide services or make items for sale.  They can also include intangible assets such as websites.  Note that for very large items of expenditure on assets, the cost may be spread over many years rather than just the year in which the cost was incurred – via capital allowances. 

Allowable expenditure – mixed business / private use

The trickier costs are those that relate both to private and business use.  The key to claiming these is to have a credible method of allocating actual costs between private and business use for items such as if you work from your own home:

Utility bills, rental payments or interest on mortgage payments, council tax – these can be allocated by identifying both floor space and time devoted to business activities. As an alternative, it’s possible to claim an HMRC fixed amount based on hours worked at home.  These rates are low however (starting at £10 pm for 25 to 50 hours pm and capped at £26 pm for 101 hours or more pm).

Telephone and internet charges – these can be allocated on the basis of the ratio of business calls to all calls. 

Vehicle Costs – As an alternative to claiming the mileage rates above, a Sole Trader can claim capital allowances on the purchase price of the car (dependent on the list price and CO2 emissions) plus the running, insurance and maintenance costs.  All these costs need to be split between business and personal use on the basis of the mileage data.

Allowable expenditure - timing

Every revenue and cost needs to have a date so that they can be allocated to a tax year in order to calculate any tax due.  The simplest method is to use the date on which the money either came into or left the bank account and this is called cash accounting.  Sole Traders can use this method providing their annual turnover is no greater than £150,000 pa.

The alternative it to use accruals accounting which means using a date for each revenue and cost item which reflects the date when the transaction occurred and when the unconditional obligation to pay arose – usually the invoice date.

Pre-trading expenditure

For a sole trader, expenditure incurred in the seven years prior to trading is deductible in the first accounting period. However, the expense must be allowable were the business to have been trading.

Taxes due

Income Tax and National Insurance become payable on the net profit generated by the business.  This tax must be paid ten months after the end of the tax year (same as the electronic submission of the tax return).  Thus for a year ending 5/4/2022, any tax due must be paid to HMRC by 31/1/2023.  On top of this you may well have to make an advance payment for the following year at the same time (see below)

For the tax year 2021/22 (with the return due 31/1/2023), tax rates are as follows:


Income Tax

First £12,570 – No tax payable on these earnings (unless you’ve earned £12,500 from other sources or your total income exceeds £100,000)[1]
Next £37,700 – payable at 20%
Next £99,730 – payable at 40%
The rest – payable at 45%


National Insurance class 2

First £6,515 – No tax payable (also other earnings not relevant)
If net profit is £6,516 or more, total class 2 NI is fixed at £158.60

[1] If income exceeds £100,000 the £12,570 tax free amount is reduced – by £1 for every £2 earned above the £100,000.  Thus an income of £125,140 means no tax free amount


National Insurance class 4

First £9,568 – No tax payable (also other earnings not relevant)
Next £40,708 – payable at 9%
The rest – payable at 2%

Taxes due for next year in advance

Note that if income tax and class 4 national insurance payments total £1,000 or more and are due on 31/1/2023, then you have to pay a further 50% of this amount on that same date.  This represents an advance payment for the tax year 2023/24.  Another 50% is then payable on 31/7/23 with a final balancing payment (to ensure the overall correct amount is paid) falling due on 31/1/24.

Losses

If you’ve made losses rather than profits in any year, then they’re potentially useful for any of the following:

  • Offsetting tax already paid in the previous year from the same trade
  • Carried forward so as to reduce tax on future years’ profit from the same trade
  • Offsetting tax already paid on other income in the current or earlier years


The rules of this can be quite complex and need to be considered carefully.

Losses

VAT can be ignored if annual turnover is below the VAT threshold (currently £85k pa)

If the majority of customers are private individuals, VAT exemption is important since it keeps prices 20% lower than they otherwise would have been.  However, if all or most of the customers are VAT registered companies, then they won’t mind being charged VAT since they can fully recover the cost.  Furthermore, when registering for VAT:

  • You can recover VAT on costs (20% that would otherwise be lost)
  • It’s possible to reduce the VAT rate in the first year and beyond using various special VAT schemes
  • It’s also possible to claim VAT on costs spent on goods upto four years before VAT registration (and six months for services). So keep copies of all VAT invoices relating to such purchases even though you’re not yet registered for VAT

Other tax matters

Pensions

Pension contributions remain a very tax efficient method of taking cash out of a business, but for sole traders they are not a business expense.  They’re simply a way of reclaiming tax already paid by the business.

Total annual pension contributions cannot exceed a limit of £40,000 (although its possible to boost this by adding in any unused part of the allowance from the 3 previous tax years). The contribution cannot be larger than salary[1] in order to reclaim any tax paid.

In the long term, it’s also important to keep track of the value of your pension pot(s) – readily available from the pension providers – so that the £1m lifetime allowance is not breached.  Otherwise, any subsequent income withdrawals will attract extra tax.


Childcare

Just like any other worker, its possible to qualify for two childcare schemes :

Tax free childcare

Provides £2,000 per child per year upto age 11 (or upto £4,000 upto age 17 for children with disabilities). Must be paid to an approved childcare organisation. Both parents must work for at least the minimum wage and neither must earn more than £100,000.

30 hours free childcare

Provides 30 hours free care with an approved carer for the 38 weeks of the school terms for children aged between 3 and 4.  Can be extended upto 52 weeks if less than the 30 hours per week is claimed.  Same criteria apply as for the Tax fee childcare scheme.


Entertainment & Trivial benefits

In a sole trader business, the individual is the company and therefore this person cannot be an employee.  As such, entertainment costs and trivial benefits cannot be claimed as a legitimate business expense (unlike a limited company)

[1] However, you do get a 20% tax rebate on the first £2,880 net contribution (£3,600 gross), even if no tax has been paid

Appendix - tax rates for the current tax year

For the tax year 2022/23 (with the return due 31/1/2024), tax rates are as follows:


Income Tax

First £12,570 – No tax payable on these earnings (unless you’ve earned £12,570 from other sources or your total income exceeds £100,000)[1]

Next £37,700 – payable at 20%
Next £99,730 – payable at 40%
The rest – payable at 45%


National Insurance class 2

First £6,725 – No tax payable (also other earnings not relevant)
If net profit is £6,726 or more, total class 2 NI is fixed at £163.8 for the year


National Insurance class 4

First £11,908 – No tax payable (also other earnings not relevant)
Next £38,362 – payable at 10.25%
The rest – payable to 3.25%

[1] If income exceeds £100,000 the £12,570 tax free amount is reduced – by £1 for every £2 earned above the £100,000.  Thus an income of £125,140 means no tax free amount.

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