Taxes affecting the self-employed

There are a number of taxes that small businesses must pay and it’s important to know which ones are relevant to your business, when you must pay them, and why you must pay them.

The punishments for missing or evading them can be severe, such as fines, interest or even imprisonment.

There’s also the reverse scenario, where you are able to reclaim any overpaid tax from HMRC.

This guide will help you answer several questions, and the most important are these:

• How does tax work in the UK?
• What tax will I pay?

Once you know the answers to these questions, you’ll also know which payments you should make to HM Revenue & Customs (HMRC). Here are the main taxes small business owners should know about to avoid being caught out.

Income tax

Employees don’t usually spend much time thinking about tax and National Insurance, because they don’t need to.

An employer almost certainly directly deducts these from gross monthly salary, leaving the employee with the remainder.

However, running your own business is a different matter.

More responsibility is needed and the buck stops with you; as a founder, you are responsible for paying the correct amount of tax on the profits your business makes along with mandatory National Insurance contributions.

This is done through a process called self-assessment which involves submitting details of your income and outgoings to HM Revenue & Customs (HMRC) for the tax year just ended.

You’ll need to know the differences between being a sole trader or company director, and what this means with regards to paying income tax based on the profits of your business.

In simple terms, as a sole trader you’ll start paying income tax once your profits are above your personal tax allowance of £12,570 (Correct as of March 2023).

Income tax for company directors is based upon any salary you take from the business.

This tax will be paid according to the same tax thresholds as any employee in a given company, and is usually collected via PAYE (Pay As You Earn) and paid directly to HMRC on the 22nd of each month.

Registering: Once you become self-employed you must register with HMRC within three months, or you face a penalty of £100. The details you’ll need to provide include name; date of birth; address; telephone number; National Insurance number; name and type of business and start date. You’ll be registered for self-assessment at the same time and an online account will be created, which can be accessed and updated at any time.

For more information on registering and to obtain a CWF1 form to inform HMRC of your change in circumstances, call the HMRC ‘Newly Self-Employed Helpline’ on 0300 200 3500 or register online at HMRC.

There are also a number of other considerations to take into account:

How do I fill in my self-assessment form?

Your self-employed tax return can be filed online or on paper.

Online is a more advantageous method, as you have more time to fill it in and you can check your account at any time.

Find out more about filling in the form.

If you'd like to learn more about Self-assessment, you can watch videos produced by HMRC on YouTube.

How much tax will I have to pay if I become self-employed?

This depends on a number of factors, including the amount your business turns over each year and whether you’ll need to pay Class 2 or Class 4 National Insurance.

How do I calculate how much tax to pay when self-employed?

The most reliable way of budgeting for your annual tax bill is to use HMRC’s online tax calculator.

What happens when I think I’m entitled to a rebate?

If you think you’ve paid too much tax, you can claim a rebate.

Rebates are paid by HMRC into a customer's bank account.

Contact HMRC via telephone to notify them of a mistake.

Should I get an accountant when self-employed?

This is really your own decision and may rest on your experience of dealing with financial matters, but professional assistance is recommended if you’ve no prior experience of handling your own tax return.

When do you start paying tax?

You can check all dates via the HMRC website, but the most crucial are October 31st, when paper tax returns are usually due, and January 31 (online returns).

What are tax payments on account?

After your first full year of business you may be asked for ‘payments on account’ for the current year’s estimated tax, which is a way of spreading tax payments that can be paid in addition to the tax due for the past year.

There are usually two payments to be made on 31st January and 31st July, meaning that – in effect - you could be paying one-and-a-half times the amount you were expecting in January and 50% six months later.

What happens if I don’t pay the tax I owe to HMRC?

Non-payment or failure to pay the correct amount of tax on time could result in a fine or penalty.

What records should I keep for my tax return?

Keep details of your personal and business income; sales invoices; receipts for payments made; business expenses; VAT records if you’re registered for VAT; and PAYE records if you employ staff.

Paperwork must be kept for a minimum of five years after the January submission deadline of the relevant tax year.

It's important for you to keep records from the very beginning of your self-employment both for your personal income and your business income as these records relate to different taxes.

There’s a huge amount of information on taxation on this site, which should answer many of your questions. Read our guide to tax for self-employed people.

VAT

VAT (value added tax) is paid on nearly all transactions, from food shopping to a new pair of shoes – and it’s something you must be aware of.

The standard VAT rate is currently 20% although this is always liable to change when the Government releases its budget.

You will need to register for VAT if your VAT taxable turnover in the last 12 months was over £90,000 (the current VAT threshold) or you expect your turnover to go over £90,000 in the next 30 days.

You can also choose to register if your turnover is less than £90,000.

You can start charging VAT on your sales, which is repayable to HMRC and reclaiming VAT on goods and services from your ‘effective date of registration’.

Questions to consider about VAT should include:

Will I have to pay VAT on every transaction?

Not necessarily - there are some goods and services that you won’t need to pay VAT on, including insurance, finance and credit and education and training.

However, if your business is supplying exempt goods and services it’s still important to make a note of the sale for your records.

You can find the full list of details around VAT exempt goods and services on the Government’s official website.

How can I register for VAT?

If you have, or think you will, go over the VAT threshold (which changes with each tax year) you’ll need to register through HMRC which can usually be done online.

Read our free guide on how to register for VAT.

You can learn more about VAT by watching this YouTube playlist provided by HMRC.

National Insurance

National Insurance contributions help to build your entitlement to benefits such as the state pension and maternity allowance.

Both employers and employees pay this.

Sole traders pay National Insurance Contributions (NICs) from their income in the form of Class 2 (£3.15 per week, depending on salary) and Class 4 NICs (dependent on profits).

As a director of a limited company, you’re treated as an employee and will pay Class 1 NICs Your company also pays the same.

Business Rates

If you operate your business from dedicated premises, you may be liable to pay business rates.

This depends on the type of business you run and its location, such as if it is a shop or office.

Rates operate in a similar way to council tax, and different businesses may have to pay different rates.

As mentioned before, there are many business tax relief schemes and grants available to help SMEs and companies, so it’s certainly worth investigating if any of these are relevant.

Corporation Tax

Corporation Tax is another key tax that a limited company has to pay each year, based on its profits.

This is a legal requirement, but again there are also tax reliefs and allowances that can be applied to your company profits to lower Corporation Tax liability.

We have an extensive guide on corporation tax that can be found here.

Corporation Tax is self-assessed – the company works out how much Corporation Tax it owes and files the return with HMRC, along with payment.

After filing your accounts with HM Revenue & Customs (HMRC), you’ll need to pay Corporation Tax on any profits for the financial year; money your business made after all allowable expenses and costs, such as salaries.

Corporation Tax is currently set at 25%.

Questions to consider about Corporation Tax include:

When does my small business have to pay Corporation Tax?

Deadlines vary; if your taxable profits are less than £1.5m, your business has 9 months and 1 day from the end of the accounting period to pay any Corporation Tax that’s due.

If your taxable profits are above £1.5m, then you must pay in instalments.

How do I pay Corporation Tax?

Corporation Tax is paid online.

You’ll need to quote your 17-digit Corporation Tax reference number for the accounting period you’re paying for.

How do I tell HMRC if there is no tax due?

If you’ve closed your accounts for the financial year and calculated that you don’t owe Corporation Tax, you must tell HMRC that you’ve no tax to pay – don’t assume that you don’t have to do anything.

How do I know if HMRC got my tax payment?

You can check your online HMRC account to keep track of your payments.

What tax relief and allowances are available?

Taking advantage of Corporation Tax relief and allowances should not be construed as tax avoidance - there are many legally permissible allowances that can be used to offset tax liabilities against profits.

Find out more on our dedicated page on the subject.

If you are in any doubt about Corporation Tax relief and allowances, then it might be best to enlist an expert such as an accountant to get a professional view.

Allowable expenses must follow a simple rule: the expense must be purely for business purposes.

They might include:

• Pension contributions
• Research and development tax relief
• Annual Investment Allowance (AIA)

You can find out more about capital allowances on the government’s website.

What other Corporation Tax relief and allowances are available?

Some small businesses could be entitled to Corporation Tax relief, such as those in the creative industries.

Another type of tax relief for Corporation Tax is the Patent Box, allowing certain companies that earn profits from patented inventions to claim lower rates of Corporation Tax.