HMRC’s tax rules can be a minefield for sole traders. Don’t forget, if you’re running a sole trade business, you are the business – you’ve not set up a company through which to trade. This means that you are personally liable for any taxes due. It’s important, therefore, that you have a basic understanding of the tax system. So here we go …..
What taxes will I pay on my business profits?
Income tax and the self-assessment system
You should register with HMRC for self-assessment and pay income tax on your taxable business profits.
The basic rate of income tax is currently 20% once you’ve used your personal allowance (£12,500 in 2019/20).
The higher rate of income tax of 40% is due when your taxable income from all sources (not just your business profits), and after using the £12,500 personal allowance, exceeds £37,500 in 2019/20.
If you have taxable personal income over £150,000, you’ll start to pay the additional rate of income tax of 45%.
Under the self-assessment system, you must complete and file a tax return and pay any tax due, for every tax year ending on 5 April. This system is enforced by penalties for failure to comply within set time limits and by interest on late payment of tax.
National insurance contributions (NICs)
Sole traders currently pay two types of national insurance:
- Class 2; and
- Class 4.
Class 2 NICs are paid at a flat weekly rate of £3.00 in the tax year 2019/20. However, no Class 2 NICs are payable if your taxable business profits are less than £6,365 in 2019/20.
Class 4 NICs are based on the level of your business profits. Class 4 NICs are calculated by applying a fixed percentage to your taxable business profits in 2019/20, as follows:
- on taxable business profits between £8,632 and £50,000 – 9%; and
- on taxable business profits above £50,000 – 2%.
When do I pay tax on my business profits?
Income tax and NICs (Class 2 and 4) are collected by HMRC through the self-assessment system.
The self-assessment system may result in a sole trader making two payments on account and a final balancing payment of income tax and NICs for each tax year.
Payments on account are only required for income tax and Class 4 NICs (not Class 2 NICs). If relevant, payments on account are due on:
- 31 January in the tax year – 1st payment on account (e.g. 31 January 2020 for the current tax year 2019/20);
- 31 July after the end of the tax year (e.g. 31 July 2020 for 2019/20) – 2nd payment on account; and
- 31 January after the end of the tax year (e.g. 31 January 2021 for 2019/20). This is the final balancing payment to settle any remaining income tax and NIC liability.
For sole traders with no other taxable income (e.g. employment income), payments on account of income tax and Class 4 NICs are equal to 50% of the total tax and NICs of the previous tax year. However, payments on account are not required if the total tax and NICs of the previous year are below £1,000.
HMRC issues payslips/demand notes in a credit card type statement of account, but there is no legal obligation for them to do so. It’s your responsibility as a taxpayer to pay the correct amount of tax on the due dates.
Payments on account of Class 2 NICs are not required. Instead, Class 2 NICs are paid as a single sum on 31 January after the relevant tax year.
Other taxes which may impact you
Employment taxes
If you take on employees, you will have to register with HMRC as an Employer for PAYE. You will then have to run a payroll, comply with HMRC’s Real Time Information reporting requirements and pay PAYE income tax and employer/employee Class 1 NICs to HMRC.
PAYE income tax and NICs are normally paid to HMRC monthly. For electronic payments, payments must be made to HMRC within 17 days of the end of the tax month (tax months end on the 5th of each month). For example, your payroll for January 2020 will give rise to a PAYE/NIC liability due to HMRC by 22 February 2020.
However, if your average monthly payments under the PAYE system are less than £1,500, you can choose to pay quarterly.
VAT
If your annual taxable turnover exceeds the current VAT threshold of £85,000, you are required to register for VAT. You will then have to submit Making Tax Digital compliant VAT returns and pay any VAT due to HMRC.
VAT returns are normally prepared every quarter. You have 1 month and 7 days after the quarter-end to submit your return and pay any VAT you owe.
If you’re in a regular VAT repayment position, you can apply to submit monthly VAT returns, to receive your VAT repayment sooner.
There are also certain VAT schemes which may be of benefit to sole traders. These include:
- the cash accounting scheme;
- the annual accounting scheme; and
- the flat rate scheme.
All these schemes have qualifying conditions and advantages/disadvantages. It’s important to assess the schemes carefully before making applications to join them.
Construction Industry Scheme (CIS)
The CIS scheme may apply to you if you act as a contractor or subcontractor under a contract which relates to a construction operation. The scheme had to be introduced to counter tax evasion when subcontractors were performing work for contractors, but were not treated as employees under the PAYE system.
The CIS scheme is complex and imposes obligations on both contractors and subcontractors. If you think this scheme impacts you, take advice from a qualified accountant.
The above is a summary of the key taxes, which may impact sole trade businesses. Tax and HMRC compliance are challenging at the best of times. If you need help from an expert Chartered Accountant, get in touch for a no-obligation, free discussion – see our Contact Us page for how to reach me.
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Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Whyatt Accountancy and the writer accept no responsibility for any loss arising from any action taken or not taken by anyone using this material.