| An Introduction
to the Tax System for the Self Employed
Registering with HM Revenue & Customs
If you start working for yourself, you must register with HM Revenue
& Customs within the first three full months of self employment.
Otherwise you may be liable to a penalty of £100. You may
register by telephone or by using the form incorporated in leaflet
P/SE/1 (Thinking of working for yourself?).
Once you become self-employed, the tax rules are quite different
from those that may have applied when you were an employee. Instead
of 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 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.
What profits do HM Revenue & Customs tax?
The starting point for the calculation of taxable profits is your
profit and loss account. In calculating taxable profits you are
entitled 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 showing the original purchase as private
expenditure (drawings).
Tax is payable on the whole of the 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
what is done.
How does HM Revenue & Customs 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.
The general rule is that the tax for a particular tax year is based
on the profits of the twelve months to your accounting date in that
tax year. For example, the tax for 2006/07 could be based on accounts
for a year ending on various dates ranging from 6 April 2006 to
5 April 2007. This demonstrates that you get more time for the tax
to be worked out if your accounts end early in the tax year, which
is why 30 April is such a popular year-end for self-employed people.
How is the tax collected?
Tax returns
Tax returns covering income for the year ending 5 April 2007 have
to be submitted to HM Revenue & Customs by 31 January 2008 (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 by 30 September 2007.
There are automatic penalties for late filing of tax returns.
Payment of tax
Payments on account of income tax and Class 4 NIC will be due on
31 January 2007 and 31 July 2007. These interim payments will be
based on one half of the total liability (less any tax deducted
at source) for 2005/06. You will have the right to reduce payments
on account if you believe the income tax for 2006/07 will be lower.
The balance of income tax for 2006/07 is due on 31 January 2008
(along with the first interim payment for 2006/07 and any capital
gains tax for 2006/07).
Interest and surcharges will be levied for late payment.
An Introduction to Self Assessment
It is a fundamental part of the self assessment system that responsibility
lies with you, the taxpayer, to file Returns and pay the right amount
of tax, at the right time - you must not wait for the Inland Revenue
to ask.
Tax returns
Tax returns covering income for the year ending 5 April 2007 will
be issued on or after 6 April 2007, and will consist of a main tax
form and backing schedules. Your tax office will send out what they
think are the relevant schedules. If you need other schedules you
will have to ask for them. The completed full return has to be submitted
to HM Revenue & Customs by 31 January 2008 (the 'filing date').
If you don't want to work out your own tax bill, you must send
the tax return in by 30 September 2007. However, you should note
that your return must be completed as far as the total income on
which tax has to be paid. Figures must be given for every item,
even if only estimates. It is not possible to enter question marks
or leave the tax inspector to decide whether an item is taxable
or not. The only section that can be left for the tax office to
complete is the actual calculation of the tax due on your total
income.
If you have taxable income or capital gains for 2006/07 and have
not received a tax return, you must advise your tax office by 5
October 2007 at the latest.
There are automatic penalties for late filing of tax returns. Failure
to submit the tax return by 31 January incurs a £100 penalty.
If it has still not been returned six months later, a further £100
will be charged. However, the penalties charged cannot exceed the
total amount of tax due. In the most serious cases, there are provisions
for penalties of up to £60 a day.
Amendments, investigations, and record keeping
You have one year from the filing date to make any amendments to
the return. HM Revenue & Customs may correct obvious errors
or mistakes within nine months of receipt of the return.
Within a period of one year from the date the tax return was due
to be submitted (or when it actually was submitted, if later), HM
Revenue & Customs will have a right to make enquiries to check
that the tax return has been correctly completed. No reason for
the enquiry need be given.
All records relating to the return should be kept during this one-year
period. If trading or rental income is involved, all records should
be kept for a further four years.
Determinations
If a return is not submitted by the due date, HM Revenue & Customs
can, within five years of the filing date, make an estimate to the
best of its information and belief of the amount of tax due. This
amount of tax will be payable without appeal, but will automatically
be superseded when the return and self assessment are sent in.
Payment of tax
Payments on account of income tax (and Class 4 national insurance
contributions) for a particular tax year will be due on 31 January
in the tax year and 31 July following the end of the tax year. These
payments will be based on one half of the total income tax liability
(less any tax deducted at source) for the previous tax year. You
have the right to reduce payments on account if you believe the
income tax for the current year will be lower than that for the
previous year. However, you may be charged interest if the reduction
is more than it should be. Payments on account will not be required
where each payment works out at less than £250.
Surcharges and interest
An automatic surcharge of 5% will be levied on any 2006/07 tax outstanding
at 28 February 2008, and a further surcharge of 5% will apply to
any tax still outstanding at 31 July 2008. There is a right of appeal
against the surcharge on the grounds of reasonable excuse.
In addition, interest will run on tax (and surcharges and penalties)
paid late, from the due date of payment to the actual date of payment.
HM Revenue & Customs will pay interest on amounts overpaid,
from the date of payment (or the due date if later) to the date
of repayment.
Self assessment for employees
For employees, self assessment is not too drastic. The PAYE system
means most employees should pay the correct amount of tax at source.
An employee with relatively straightforward tax affairs is unlikely
to be asked to complete a tax return.
Tax codes
The main cause of under or over payments of PAYE is actual benefits
in kind being different from the estimates included in the tax code.
If there are under-payments of tax, they may be collected by direct
demand or, if modest, carried forward as an adjustment to their
tax code for the next tax year, but one. Self assessment allows
up to £2,000 to be carried forward in this way, provided HM
Revenue & Customs is given all the relevant details by 30 September
following the end of the tax year.
Information deadlines
So that employees can complete their tax returns properly, information
deadlines are imposed on employers:
- Forms P60 must be provided to employees by 31 May following
the end of the tax year
- Copies of forms P11D and P9D must be provided to relevant employees
by 6 July following the end of the tax year
- Form P45 has a part for the employee to retain
Child Tax Credit and Working Tax
Credit
These tax credits replaced Working Families' Tax Credit, Disabled
Person's Tax Credit and Children's Tax Credit and the child-related
elements of Income Support and Jobseeker's Allowance.
Although they are administered by HM Revenue & Customs, these
credits have nothing to do with the tax system and are not connected
with how much tax you pay.
The general rule is that to qualify for tax credits you must be
aged 16 or over and usually live in the United Kingdom. To receive
your entitlement to tax credits, you need to claim them using a
paper form TC600 or online at the HM Revenue & Customs website
(www.inlandrevenue.gov.uk/taxcredits). If you don't already have
a claim pack you can get one by telephoning 0800 500 222.
Couples must claim tax credits jointly, and entitlement will be
based on the combined income of both partners.
Child Tax Credit (CTC)
CTC replaced the Children's Tax Credit and the child-related elements
of Working Families' Tax Credit and Disabled Person's Tax Credit.
CTC can be claimed by families with at least one child, and annual
family income up to about £58,000.
It provides support for
- children until 1 September after their 16th birthday
- children aged 16 to 18 who are in full time "non-advanced"
education (ie studying for at least 12 hours a week and the course
leads to A level, NVQ level 3, or below)
- children aged 16 to 18 who have left full time education but
do not have a job or training place and have registered with the
Careers Service or Connexions Service, and are not claiming Income
Support or tax credits in their own right
The amount of benefit is dependent on the number of children in
the family, whether they have disabilities, and the total family
income. It will be paid direct to the person who cares for the children.
CTC is made up of the following elements:
- A family element that is payable to any family responsible for
a child. It is paid at a higher rate to families with at least
one child under the age of one.
- A child element for each child the family is responsible for.
This is paid at a higher rate if the child has a disability and
at an enhanced rate for a child with a severe disability.
The basic family element of £545 per year is available in
full to all families with joint income up to £50,000, with
a tapering reduction up to income of about £58,000 (£66,000
for families with a child under one year old).
CTC will be paid directly through a bank account to the person
who is mainly responsible for caring for the children in the family,
either weekly or every four weeks.
Working Tax Credit (WTC)
WTC is a tax credit for people in paid work who are on a relatively
low income (for couples, joint income), including those with a disability.
It replaces adult-related elements of Working Families' Tax Credit
and Disabled Person's Tax Credit. It also includes support for the
cost of eligible childcare.
WTC is for people who are employed or self employed (either on
their own or in partnership) who
- usually work 16 hours or more a week
- are paid for that work, and
- expect to work for at least 4 weeks
and who are:
- 16 or over and responsible for at least one child, or
- aged 16 or over and disabled, or
- aged 25 or over and usually work at least 30 hours a week
WTC is paid to the person who is working 16 or more hours a week.
Couples where both work 16 hours or more a week may choose which
of them will receive it. Claimants will receive their payments directly
from HM Revenue & Customs. The childcare element of WTC will
always be paid direct to the person who is mainly responsible for
caring for the child or children, alongside payments of CTC.
Basis of assessment
Tax credit awards are based initially on income for the previous
year. At the end of the tax year, when income for the year is known,
the tax credits position is finalised. Any increase in income will
be ignored to the extent of £25,000, but income above this
limit will result in a reassessment.
During the year
- If income rises significantly, you should tell HM Revenue &
Customs so that the award can be adjusted. Otherwise, you may
receive too much tax credit and have to pay it back when the award
is finalised at the end of the year
- If income falls, you can ask to have your tax credits paid
on the basis of an estimate of your income for the year. But if
you do that, you will have to tell HM Revenue & Customs straight
away if you think your income will be higher than your estimate
- Any relevant change in circumstances must be notified to HM
Revenue & Customs within three months
Income for Tax Credit purposes
Income is broadly aligned with the claimant's gross taxable income
(i.e. before the deduction of income tax and National Insurance
Contributions). Earnings will be taken from P60 certificates for
employees and self assessment returns for self employed claimants.
There are, however, exceptions to the alignment, including:
- not all benefits in kind are included
- the first £100 of statutory maternity pay (and their
new equivalents) does not count
- apart from earnings and taxable social security benefits, most
other annual income is taken into account only to the extent that
it exceeds £300
- Contributions to approved pension schemes and payments under
the Gift Aid scheme are deducted
It is very important to understand that tax credits cannot be
backdated for more than three months. Please ask us for further
information regarding failing deadlines or refer to the tax credit
website at www.taxcredits.inlandrevenue.gov.uk/Home.aspx.
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