Written by Mark Williams
Becoming self-employed (also known as setting up as a sole trader) remains the most common way to start a business. Out of a total UK business population of 5.7m, about 3.4m (59%) are sole traders (source: The Federation of Small Businesses).
Sole traders are liable for their business debts, which is why others choose to register a private limited company, of which they become managing director. The UK has 1.9m private limited companies, making up 34% of the total business population. The main advantage is a company is separate legal entity, which means that in normal circumstances, its directors are not personally liable for the company’s debts.
What tax do you pay as a sole trader?
As a sole trader you must keep accurate, complete financial records of your sales and expenses, and complete and file a Self Assessment tax return every year. You pay income tax on your profits, as well Class 2 and Class 4 National Insurance contributions. You must become VAT-registered if your business turnover is more than £85,000 a year. Each quarter, you must then pay HMRC any VAT your business owes (you can reclaim any VAT your business has paid).
To avoid an “enforcement action”, you must pay HMRC any tax owed by your business. There are steps you can take if you can’t pay HMRC tax you owe. Interest can be charged for late payment, while there are penalties for late submission of your tax return.
Where information is incorrect on your tax returns, the consequences will be determined by whether HMRC considers your actions to be “careless”, “deliberate” or “deliberate and concealed”, with penalties ranging from a simple fine to criminal prosecution.
Sole trader allowable expenses
As explained on government website, gov.uk: “If you’re self-employed, your business will have various running costs. You can deduct some of these costs to work out your taxable profit, as long as they’re allowable expenses.” It gives an example of a sole trader with turnover (ie total sales) of £40,000 a year, who pays tax only on £30,000 of that because they have “allowable expenses” of £10,000 a year.
As examples of allowable expenses for sole traders, it lists: office costs (eg stationery or phone bills); travel costs (eg fuel, parking, train or bus fares); clothing expenses (eg uniforms); staff costs (eg salaries or subcontractor costs); things you buy to sell on (eg stock or raw materials); financial costs (eg insurance or bank charges); costs of your business premises (eg heating, lighting, business rates); advertising or marketing (eg website costs). You can also claim for accountancy fees.
If you run your business from your home or have an office for your business at home, you can claim a proportion of your costs for heating, electricity, Council Tax, mortgage interest or rent, internet and telephone, etc. The proportion for which you claim must be reasonable, so, if, for example, you live in a flat with four rooms, you claim for a quarter of such costs, and you might claim for 70 per cent of your internet and phone bills, etc. To avoid complex calculations, sole traders can claim simplified expenses.
What can’t sole traders claim for?
HMRC will only allow expenses that are “wholly and exclusively” for business purposes. If something is used for both business and personal reasons, allowable expenses can only be claimed for their business use. So, if you use your mobile phone for business for roughly half of the time, you can only claim half of the monthly charges as an allowable expense. And only calls made for business can be claimed, too.
You cannot claim for your lunch every day as a matter of course. However, you can claim a meal as “subsistence” if it’s outside of your normal working routine, for example, if you’ve travelled to an exhibition or client meeting.
You can also claim for reasonable accommodation for legitimate business reasons, although you should opt for a budget hotel rather than five-star luxury.
Travel, health and pension costs
If you use your own car for business, you can claim 45p per mile for your first 10,000 miles in the tax year and 25p per mile thereafter. You can’t claim if you’re simply commuting from home to your normal place of work.
Sole traders cannot normally claim for health and medical insurance costs, nor pension payments, although personal tax relief for private pension contributions is available. You can claim for membership subscriptions paid to relevant professional organisations and relevant vocational training.
People sometimes have some weird ideas about what sole traders can claim for. So, just in case you were wondering, you cannot claim for parking fines or speeding tickets, entertaining clients, childcare or school fees, a flashy new business suit, gym membership or getting your hair cut. Gov.uk recommends contacting the Self-Assessment helpline if you’re not sure whether a business cost is an allowable expense.
What about capital allowances?
To further reduce your tax bill, your sole trader business may be able to claim capital allowances for buying equipment, machinery or business vehicles. Referred to as “plant and machinery”, you may be able to deduct some or all of the value from your profits before your tax bill is worked out.
And, finally, you may also be able to claim for things you paid for to get your business up and running, before it started trading. Seeking advice from a recommended small-business accountant can help you to claim all that is due to your sole trader business.
Mark Williams is a freelance editorial consultant, editor, journalist and SME content specialist with more than 25 years’ experience. He has written for The Guardian, numerous leading brands and award-winning magazines and websites. Visit www.markiwilliams.com