Interested in Self-Employment? Here’s What You Need To Know
What does it mean to be self-employed? Can I simultaneously be employed and self-employed? What records do I need to keep? What are my tax obligations?
These are common questions for someone deciding to start a business of their own. And if you’re self-employed or considering taking the leap, you’re not alone.
Levels of self-employment are higher than at any point over the past 40 years. In 2014, 4.6 million people were self-employed, with 15% of these people classifying self-employment as their main source of income.
Given these huge numbers, the government commissioned an independent review of self-employment by entrepreneur Julie Dean and published the results in February 2016. It revealed that one of the most common areas where people require support was for record-keeping, so we’ll look at in greater detail in this blog.
Three main questions of self-employment in the UK we’ll consider here are:
1. What is self-employment?
2. As a self-employed person, what do I need to do?
3. How do I keep records?
1) What is self-employment?
Sole traders and partners are classed as self-employed by HM Revenue and Customs (HMRC). You’ll most likely be considered self-employed if you:
Operate your own business
Can have several customers at the same time e.g. a self-employed cleaner who works at several homes, a lawyer who has several clients, etc
Can decide the way your business is to be run (e.g. the hours, place of work, pricing and profit elements)
You can be employed and self-employed at the same time. For instance, if you work in the morning for an employer and for a freelance business in the evenings or weekends.
2) As a self-employed person, what do I need to do?
Once you’ve decided to run your own business, your legal obligations include:
1. Registering as self-employed with HMRC
2. Maintaining appropriate records of your business turnover and expenses
3. Paying the necessary taxes and National insurance contributions
Ideally you should register with HMRC immediately after starting your business. The deadline is by 5th October of the second tax year of your business. For example, if you started your sole trader business in May 2015, let HMRC know by 5th October 2016.
The registration process for those starting a new business involves informing HMRC of both taxes and National Insurance contributions through an online form. The form to use depends on whether you have filed Self Assessment tax returns in the past or not.
Registration takes about 10 days for the registration to be completed. Once complete, the business can report income at the end of each tax year using Self Assessment returns, and pay taxes and National Insurance on time.
3) How do I keep records?
Record-keeping is one of the most important areas of running a new business.
“It may seem like a challenge, particularly when you’re starting out, but keeping good records will bring real advantages to your business. Get a proper system in place and you’ll not only be confident that you are paying the right tax, but you’ll keep up-to-date with how much you owe suppliers and how much you are owed” — Brian Redford, Spokesperson for HMRC
Many self-employed people consider record-keeping a daunting task. But it can straightforward if appropriate systems are established when a new business is started, and regularly updated.
Your business needs to keep track of all money coming in and going out. This includes:
- Sales and income (sales invoices, bank slips, receipts from customers)
- Business expenses (purchase invoices, supplier payments, bank statements, cheque book stubs)
- Payroll records (if staff are employed)
- VAT records (only if the business is VAT registered)*
- Records about personal income
*VAT registration threshold for 2015-16 is set at £82,000. The threshold is based on the business turnover during the 12 months, and may vary each year based on the budget announcements.
The exact records to be kept by the business depend on its size, nature and the accounting method used. This accounting method could be:
- Cash basis – this works well for small businesses with income of less than £82,000, as businesses only need to declare what cash came in and went out of the business. This information is readily available from the business bank statements.
In this method the income and expenses are recorded when actual cash is received or paid by the business.
- Traditional (accrual) basis – this method is used by most businesses. Here, the income and expenses are based on the date invoices are raised or when expenses are billed.
In order for tax returns to be reflected appropriately, the business needs records for:
- Details of stock and cash/bank balances at the end of the accounting period
- Money invoiced but not yet received (called Accounts receivable
- Money committed to be paid, but not yet paid (called Accounts payable)
- The owner’s capital invested into the business
- The owner’s drawings (amount taken out of the business)
Simplified expenses – From the 2013-2014 tax year onwards, there’s also the option for a sole trader or partnership business to use simplified expenses with the above methods.
Simplified expenses can be claimed for:
a) Business costs for vehicles
b) Business use of a home
c) Private use of business premises as a home
Under this method, businesses can record the business miles for vehicles, hours worked from home and the number of people living in the business premises during the year. They then apply a flat rate to the above calculations and derive the business cost that they can claim as expenditure, instead of recording the actuals.
Irrespective of the accounting method chosen, it’s important to choose a suitable accounting reference date. Accounting reference date is the financial year-end date for the business, and the financial year normally runs for 12 months. For example, the businesses could choose the anniversary date of the business start as the accounting reference date. Most businesses choose 5th April to make tax calculations simple (5th April is the end of the UK tax year).
Why is record-keeping essential?
Businesses need to keep records to calculate the profit or loss made during the tax year, to report annual tax returns to HMRC. Depending on the profits, taxes and National Insurance (NI) payments need to be made.
A ready reckoner (a tool to budget for self-employment tax and the NI bill) is available here on the HMRC website. Simply enter your estimated weekly or monthly profit and get an immediate estimate of the taxes and NI to be paid for the tax year.
Records must be kept for at least 5 years after the 31 January submission deadline of the relevant tax year. HMRC may check records to ensure the right amount of tax is paid, so maintaining accurate records for this length of time is essential. HMRC may charge interest and penalties if sufficient taxes haven’t been paid or if records aren’t correct, complete and readable.
HMRC now provides a range of digital customer support products tailored for different self-employed businesses, such as guides on record-keeping.
Following consultations with HMRC, many software suppliers have also produced simple record-keeping apps to help small businesses maintain their records correctly. Most of these apps are freely available.
The above technological developments, combined with support tools from HMRC, mean that there are plenty of resources available to self-employed businesses to manage their records in a timely and efficient manner.
To summarize, we have looked at the meaning of self-employment, the obligations of self-employed people towards taxes and NI in the UK and finally the record-keeping aspects. Several resources are available at the gov.uk website, which can help you set up a self-employment business and ensure ongoing compliance with the regulations.
This post was written by Viji Mohankumar, a Chartered Accountant with 18 years’ experience in multinational companies such as General Electric, Ernst and Young, HSBC and Barclays Bank. If you want to find out more about accounting, take a look at our Basic Accounts UK course here.