This resource offers a guide to help you understand some of the basics behind the way self-employed people are taxed. These notes are not intended to be definitive and, with limited space available, can only deal with the basic principles. They have been prepared using information current in the 2019/20 tax year. Please note that the tax and National Insurance (NI) rules are constantly changing – one reason why professional advice is always important.
This document has been through due diligence, but it is emphasised that no responsibility can be taken for any action made or not made as a result of the contents.
[hidden title="Registration with HMRC"]
These days, HMRC (Her Majesty’s Revenue and Customs) expect you to Register online – should be done within three months of starting self-employment or you will face a penalty of at least £100. They will then send you a ten digit “Unique Taxpayer Reference” number (UTR for short) – this is important and will stay with you for all of your dealings with HMRC. Registration will cover both tax and National Insurance.
If you get stuck, you can call the HMRC helpline (0300 – 200 3300) but be prepared to wait in a queue! If you have an accountant, they can help you with this process.
Most illustrators work for themselves and their tax status is “self-employed”. HMRC is interested in collecting tax and NI on the profit you make. “Profit” is the difference between your sales income and the allowable expenses in your business.
[hidden title="The tax year"]
For weird and wonderful historical reasons, the UK tax year starts on the 6th April and ends on the following 5th April. So, a tax year starting on 6th April 2019 will end on 5th April 2020 and this is known as the 2019/20 tax year.
The business year end can be on any date, however it becomes more complicated to prepare when not based on the tax year. The simplest way of declaring your earnings to HMRC is to coincide your business accounts year with the tax year. Hence your year-end would be 5th April, (alternatively 31st March, which for convenience, HMRC treat as being the same as 5th April), and you will be reporting the profits made between the 6th April one year and the following 5th April, (alternatively 1st April to 31st March), in the tax return.
[hidden title="The tax return"]
All people with self-employed (freelance) income are required by HMRC to fill in a tax return each year. This covers ALL types of income (for example, self-employed income, earnings from employment, interest received) and other relevant information for a tax year.
HMRC may send you a simplified four page tax return or they may ask for a full tax return which comprises a main return (eight pages) and one or more “sub-returns” for each different type of income.
It is a good idea to fill in and submit your tax return to HMRC as soon as possible after the end of the tax year. Doing this gets it out of the way and also lets you know your tax and NI bill sooner rather than later, giving you more time to save up for the payment!
The filing deadlines for tax returns are: 31st October after the end of the tax year if you are filing a paper tax return; or the following 31st January, if you are filing online. If you miss the deadline, there is an automatic penalty of £100, rising rapidly by £10 a day if your tax return is more than three months late.
Once HMRC have processed your tax return, they have twelve months after the following 31st January filing deadline to make a compliance enquiry or to ask any questions. If you do not hear from them, this means that there are no concerns with the information provided.
HMRC are encouraging taxpayers to file online but there is a separate one-off registration process for online filing. HMRC will send you an “activation” code through the post – this takes up to ten working days and once you have input this, you can file your Return. Don’t leave the filing of your tax return until the last minute – especially your first one.
Please note that, as a taxpayer, it is your responsibility to make the declaration of your profit and other income in the year whether you receive a notice to submit a tax return or not. By law, any untaxed or undertaxed income must be declared. All people with self-employed income are required to submit a tax return.
[hidden title="Tax rates and bands"]
Everyone can earn an amount of income that is tax-free in a tax year: this is known as the single personal allowance. In the 2019/20 tax year, the amount is £12,500 – it changes most years.
Between an income of £12,500 and £50,000 in 2019/20, tax is charged at 20%, known as the “basic rate”. If you are successful enough to have an income above £50,000 (up to £150,000), this is charged at 40% (the “higher rate”).
Remember that, for self-employed people, it is the profit that is taxed rather than sales income (profit is sales income less allowable business expenses).
[hidden title="Bookkeeping points"]
It is important to maintain a list of your sales invoices and business expenses throughout the period – and to write up your books and records regularly.
Your sales list should include columns for: date/description/invoice number/total amount/date of payment by client.
It is best not to obtain work from just one source during a tax year as this is one factor which may lead HMRC to challenge your self-employed status and instead claim that you were an employee of this client. You may then lose one of the main advantages of working freelance, which is tax deductibility on a wide variety of business expenses! In addition, evidence of your seeking other clients would help – for example business cards, advertising or a list of appointments with potential clients.
Your list of expenses is also best laid out in column format with: date/description/reference number/total columns and then a column for each main category of expense (e.g. art materials, travel, phone). The net profit figure (sales less allowable expenses) is the basis on which your tax liability will be calculated.
You should keep supporting documents for as many of your expenses as you can (suppliers’ invoices, till roll receipts etc) – and these should be retained for at least seven years, in case HMRC wish to look at them.
Note not all business expenses are tax deductible, which is why HMRC have a list of allowable expenses.
You can only claim tax relief for expenses which are incurred wholly and exclusively for business purposes. However, HMRC do allow a proportion of business use to be claimed against expenses which are both used privately and for the business. For example, motor expenses, if you have a car which is used for both business and private use; rent and telephone, if you work in the place you live. It is advisable to record the total amounts spent on these ‘dual purpose’ expenses and then use a realistic apportionment at the end of the year. This latter figure will be the amount to take into your year-end tax return or accounts as a tax-deductible expense.
The good news is that your AOI membership subscription IS tax deductible.
[hidden title="Capital Equipment"]
Tax relief for capital equipment (items which last for more than one year e.g. a computer) is given differently to tax relief on items that are used up quickly such as art materials, travel etc. At present, the whole of the amount spent on capital equipment (excluding cars) is given tax relief against sales income. However, it is disclosed separately in the tax return in the “capital allowance” section under “annual investment allowance”.
Equipment bought before being used in the business will be valued at market value not cost at the date you started the business – and are only allowed tax relief at a current rate of 18% a year on the “reducing balance” basis. Gets a bit complicated at this stage. When an item is disposed of or scrapped, the proceeds should be set against the remaining value of the equipment that has not yet been granted capital allowances.
[hidden title="Payment of Tax"]
Self-employed tax and National Insurance is paid on the 31st January and 31st July. It is rather complicated! It is best looked at by taking the example of a newly started illustrator.
Sarah started trading as a self-employed illustrator on 1st September 2019 and her year end is 31st March 2020. Her tax/NI bill for her first accounting period (the 7 months from 1st September 2019 to 31st March 2020)is £500; for her second accounting period (1st April 2020 to 31st March 2021), £2,000; and for her third accounting period is £3,000. Her tax is due to be paid as follows:
1. 7 month period to 31st March 2020 (tax year 2019/20): Sarah’s tax/NI bill (£500) is due on 31st January 2021 – this payment date (the 31st January after the end of the tax year) is known as the “balancing payment” date. It is less than £1,000, so Sarah does not have to make up-front payments for the following tax year (2020/21). These up-front payments are called Payments on Account. She does not have anything to pay on 31st July 2021.
2. Year ended 31st March 2021 (tax year 2020/21): tax/NI bill of £2,000 is due on 31st January 2022. However, this time, she has to make Payments on Account for the following tax year (2021/22) because her tax bill for 2020/21 was more than £1,000 (it was £2,000). The Payments on Account are calculated as 50% of the previous year’s tax bill – so, her two Payments on Account will be £1,000 each, payable on 31st January 2022 and 31st July 2022. This means her total tax/NI paid on 31st January 2022 will be £3,000 and on 31st July 2022 £1,000.
3. Year ended 31st March 2022 (tax year 2021/22): tax/NI bill of £3,000. Sarah has already paid £2,000 of this liability in two equal Payments on Account on 31st January 2022 and 31st July 2022. This means that the amount she has to pay on 31st January 2023 (the balancing payment date) is £1,000 (£3,000 liability for the year less the £2,000 already paid). Because the 2021/22 liability is more than £1,000, she then has to make two Payments on Account for the next tax year, 2022/23: 50% of the 2021/22 tax/NI bill, £1,500. The Payments on Account for 2022/23 are due on 31st January 2023 and 31st July 2023. Sarah therefore pays £2,500 in total on 31st January 2023 and £1,500 on 31st July 2023.
If your allowable expenses exceed your sales income for the accounting year, you have made a trading loss and the taxable position assessable in the tax year would be £nil. A trading loss can be increased by capital allowances.
Losses can be beneficial. A claim can be made to offset the loss against other income of the same year, to carry it back to the previous tax year and offset against that year’s total income, or can be carried forward to use against future trading profits.
You do not have to register for VAT compulsorily unless your turnover (sales income) in any preceding 12 month period has exceeded £85,000 (with effect from 1st April 2017). You can voluntarily register for VAT if your turnover is below the compulsory registration threshold.
Once registered, this means that you will have to add 20% VAT to your sales invoices to customers in the UK. Special rules apply to customers in the EU and outside of the EU. However you can reclaim the VAT that you have paid to suppliers on expenses such as advertising and equipment. You would usually file a VAT Return quarterly on the HMRC website. Bookkeeping requirements are more stringent when you are registered for VAT and it is important to keep full records of sale invoices and expenses, as you may be inspected.
Most illustrators do not register for VAT unless they have to!
This resource has been prepared by Nick Weeden, Chartered Accountant. All members are entitled to an hours free consultation with Nick. If you have any difficulties do not hesitate to contact HMRC or take advantage of your free consultation with Nick by emailing the AOI.