Last year, we looked at the significant increase in freelancers at the beginning of the coronavirus pandemic, with 200,000 people becoming self-employed between January and May 2020. Becoming your own boss can be both exciting and scary, particularly during such uncertain times. That’s why we’ve created this guide to help you manage your taxes as a freelancer, so you have one less thing to worry about.
What Different Types of Freelancers Are There?
When becoming a freelancer, it is important to know whether you intend to become a sole trader or whether you’re planning to set up as a limited company. Let’s take a look at them both in greater detail to help you decide which you are:
In the UK, 60% of small businesses are set up by sole traders, making it the more popular option for the two. This is because it is a far easier and more straightforward way of getting your foot in the door to the business world compared with setting up a limited company. It’s also much more affordable, making it particularly appealing to those looking to start a business in the middle of the pandemic.
Unfortunately, the downside of being a sole trader is the responsibility they hold for all liabilities of your company. This means if something were to go wrong, you could potentially lose large amounts of money and your belongings, including your home.
A limited company is considered to be its own entity. As a director of the company, you would be classed as an employee. Although this means you will have to handle two sets of tax issues (personal and business tax), the upside is that as an employee you aren’t held responsible for any of the company’s debt and your property will not be at risk in the event of something going wrong. However, it’s important that freelancers operating through a limited company need to be aware of IR35 legislation.
In this guide, we’ll be focusing on managing tax as a sole trader.
Managing Your Taxes as a Sole Trader
When operating as a sole trader, there are a number of things you need to do in order to comply with the UK’s tax laws.
Complete Your Self Assessment
When you start your business, the first thing you need to do is make the taxman aware that you are self-employed via a self assessment. You can register online in order to create your account with HMRC. You’ll receive a letter with your Unique Taxpayer Reference (UTR) number within 10 days (21 if you’re abroad). You’ll need your UTR to file a return.
You’ll then receive another letter with an activation code for your account. You can get a new activation code if you do not receive it or you lose it.
Once you’ve activated your account, you can file your tax return any time before the deadline, which is midnight 31 January 2021.
There are two steps to completing your self-assessment:
- Submitting your tax return. Documenting all of your taxable income for the tax year, claiming allowances and reliefs.
- Payment of tax due by 31 January 2021.
Tax returns can be submitted online at gov.uk/log-in-file-self-assessment-tax-return. Alternatively, you can submit a paper version by 31 October. As a self-employed sole trader, you will be taxed on your earnings in the current tax year. Both have very strict time limits for filing tax returns, so don’t risk it or you will face automatic penalties.
Making Tax Digital
In order to make tax administration more effective, efficient and simple, HMRC implemented the Making Tax Digital (MTD) scheme. MTD requires businesses with turnovers of £85,000+ to file their tax returns on a quarterly basis through online digital software.
Under the self-employment section of the return, it isn’t necessary to include copies of your accounts, however, you must disclose your income and expenses.
Simpler Tax Returns
Thanks to the recent simplification of tax returns for lower income businesses by HMRC, businesses with turnovers of less than £85,000 per year can submit less information. All you need to submit is your gross business turnover, total allowable deductions, capital allowances and net profit or loss.
Expenses or Allowable Deductions
If you are self-employed, any costs that are incurred exclusively for your business can be claimed back as expenses. Some examples are office rental costs, software charges and equipment such as printers, computers, telephones etc.
In order to claim expenses back from HMRC, you’ll need substantial evidence of your expenditure. To make sure you can claim all of these back, keep all records and receipts for a minimum of 5 years and 10 months following each tax year.
Capital allowances is the HMRC equivalent of depreciation, which is spreading the cost on expenses such as vehicles and equipment over their useful economic lifetime. For example a new printer may cost £300. After a year it may only be worth £240. Depreciation represents this fall.
HMRC don’t trust accountants to use a suitable depreciation policy, so created their own called Capital Allowances. If HMRC amend your self-assessment, you can appeal against the figures if you disagree with them. This must be done within 30 days following the amendment.
The self-assessment return asks if any estimates have been used. If the answer to this question is “yes”, then you need to be able to justify them.
When recording freelance income, it is common for difficulties to arise. This is because whenever you are reimbursed for expenditure, this reimbursement is counted as income. That is why you should always keep a full record of reimbursements with invoices or receipts to support your claim.
HMRC automatically asks for all bank and building society lodgements to be identified. Any money that cannot be identified will be taxed, so keeping everything recorded, including private items, is the best way to go.
If you work abroad, it is possible for you to be taxed on your income in both the UK and the country of earning, meaning you will be taxed twice for a singular income. When preparing your UK tax return, you are usually able to claim relief for the foreign tax.
This is subject to the Double Tax Treaty, a treaty that ensures your combined tax bill is no more than the amount you would pay in the higher tax rate country.
Where there is no treaty in place with the country of your work, unilateral relief will allow you to claim relief on the lower tax rate.
After You Have Submitted Your Return
Once you’ve submitted your tax return, it will initially be checked for obvious errors, such as miscalculations but any small errors will not be studied closely.
When you submit your tax return before 31 October, you will be sent information with how much tax is due to be paid by you. If you calculated the tax due yourself, you will receive confirmation or a revised calculation with information regarding the differing figures.
Within a year of your tax submission, HMRC are able to open a formal enquiry. The majority of enquiries are undertaken when an inspector suspects something is incorrect, however, there are also a number of random enquiries every year too, so don’t panic straight away if you get a letter to say your company is being audited.
The inspector will write to you and your accountant with a number of questions and requests for evidence of your income or expenses. Once the audit is completed, you will have one of three outcomes:
- You haven’t paid enough tax and are therefore required to pay more
- Nothing needs changing
- You have paid too much and are due a tax rebate.
If you are required to pay more tax, interest will be added and penalties may be imposed. These can amount to 100% of the extra tax and 200% for offshore disclosures.
What Should I Do If I Am Being Investigated?
To begin with, you should get professional advice from an accountant such as Ryans as soon as you are informed of the audit or investigation.
If you’re facing a tax audit, your accountant should check through your records and systems. This will allow you to provide accurate, up-to-date information when the inspector visits, making the audit quicker and less likely to lead to penalties.
When faced with an investigation, it is best to handle any communications with the tax inspector through your accountant, who can deal with it professionally and work in your best interest.
Don’t destroy evidence or try to lie. This will most likely lead to more severe penalties. It is worth making savings to go towards any likely tax bills to reduce the amount of interest payable and try to negotiate an agreement for a lower cost.
A tax investigation can last over several months and can expand from one section of your tax return to another. If HMRC are asking for too much information or are behaving unreasonably, your accountant can advise you on what to do.
When your turnover exceeds £85,000 a year, it becomes compulsory for you to register for VAT. However, you can register voluntarily if your turnover is below the threshold if you so wish. If you’re VAT-registered with HMRC, you have to document and add VAT to every transaction you make. You can also claim back VAT on business purchases.
There are 3 rates of VAT:
- The reduced rate of 5%
- The standard rate of 20%
The industry you’re in will determine the VAT rate you must charge. When generating invoices you must show your VAT number and information and show the ‘time of supply’ which is the date the transaction took place for when it comes to doing your taxes. You are able to reclaim VAT that you have paid for almost all business purchases and employee travel expenses so long as they are registered on your VAT return.
This return is submitted via HMRC’s Government Gateway and must include all invoices and receipts that you generate in that quarter and any import/export documents.
The best way to keep track is by using a dedicated VAT account. This account notes details of any applicable purchases or sales. Keeping this account up-to-date and allows you to calculate the VAT you owe HMRC and any VAT you can claim back.
Keeping your accounts in order is essential in the event that HMRC conducts an inspection. You must keep VAT records for at least 6 years (or 10 if you use the VAT MOSS service). They can be kept on paper, electronically or as part of a software such as Quickbooks, Sage and Xero.
To calculate your VAT tax, use our handy online VAT calculator.
Pensions and Other Tax Efficient Investments
Tax relief is available on pension contributions. On the most part, you will receive full tax relief on your payments, which can be incredibly beneficial to those paying higher tax rates. The downside is you will have to wait until you’re 55 to access the money.
Individual Savings Accounts (ISAs) and Insurance Bonds are also very tax efficient investments.
Some Final Tips…
- For those just starting out, make sure to register with HMRC as self-employed six months after the end of the year in which you started.
- When writing to HMRC, always keep a copy for yourself as this may come in handy in the future.
- Keep your receipts for everything.
- If you’re unsure of whether or not you can claim certain expenses, claim them anyway! Just make sure to keep records of them in case HMRC query it.
- Keep money saved aside to cover your tax bill when it does arrive.
Get Professional Help with Your Tax
The constant specific changes being made to tax and VAT regulations and the ever growing demands of HMRC call for a trained professional eye to ensure that you do not fall foul of the regulations and end up paying the Exchequer more than you need to!
Tax represents a significant part of your trading costs and ensuring you are compliant with the law can hold a heavy burden, especially as reporting obligations increase, investigation policies from the tax authorities become more strict and penalties for non-compliance become harsher.
Efficient tax planning can potentially result in large increases to your bottom line. Maximising your net profits whilst ensuring you’re complying with the law is a win-win.
Calculating your taxes and submitting your tax returns can take a great deal of time and resources, which is why we offer a range of services to help you minimise your tax exposure and relieve you of the administrative burden. These services include:
- Determining the most tax effective structure for your business
- Taking full advantage of tax opportunities and reliefs
- Achieving the optimum capital or revenue tax treatment
- Reducing tax on disposals and maximising relief on acquisitions
- Making good use of tax opportunities specific to your industry
- Meeting the strict demands of compliance including corporation tax self assessment
- Acting on your behalf in discussions with the tax authorities
We also provide an efficient cost effective VAT service, which includes:
- Assistance with VAT registration
- Advice on VAT planning and administration
- Use of the most appropriate scheme
- VAT control and reconciliation
- Help with completing VAT returns
- Planning to minimise future problems with HMRC
- Negotiating with HMRC in disputes and representing you at VAT tribunals
We work with you to optimise your performance with advice on funding, project planning, cash flow planning, payroll services and tax planning, recommending the most effective solutions for your business.
To save yourself a job and potentially a lot of money, why not have a chat with us to discuss our Corporate Tax Planning service? Get in touch today by calling us on 01204 523263 or by leaving us a message.
Although we have tried to make this guide as comprehensive as possible, it is not a substitute for exhaustive professional help and advice. For more tips, information and tax guides, check out our helpful blog and resources.