If you register as a sole trader, you will be required to fulfil certain legal obligations. This includes paying tax to HM Revenue and Customs (HMRC). Here is Turner Little’s Tax Guide for sole traders.
Sole trader vs limited companies
When setting up your business, you can become a sole trader or form a limited company. There are key differences between these two forms of business creation, including tax obligations. Sole trader businesses are taxed as a single entity, while limited companies are taxed as separate legal entities from their owners and directors. Sole traders are taxed each year via self-assessment tax returns and are also required, after deducting expenses, to pay National Insurance contributions on their earnings.
Self-assessment tax returns
As a sole trader HMRC will send you a self-assessment notice at the end of each tax year. You should then fill out your self-assessment tax return either on paper or online and send it to HMRC. You will need to do this by 31st October after the last tax year for paper forms, or by 31st January after the previous tax year for online forms. You must also pay all tax due for the last tax year, by 31st January.
Payments on account
As a sole trader, you are also required to make ‘payments on account.’ These are advance payments that you make to HMRC, based on your estimated tax bill for the current tax year. These payments are due in two instalments; one to be paid by 31st January and one to be paid by 31st July. Due to payments on account, your tax bill might be significantly bigger the first time you pay tax via the self-assessment system.
As an example, what would your total tax bill be if you registered as a sole trader in May 2015? Your first self-assessment tax return would cover 6th April 2015 to 5th April 2016 and you would need to pay the applicable tax by 31st January 2017. Alongside this bill for 2015/2016, you would also be required to execute an advanced payment by the same date for the 2016/2017 tax year.
So let’s say your 2015/2016 tax bill was £10,000. You would submit this and £5,000 as payment on accounts for 2016/2017 by 31st January 2016. It is vital that you take payments on account into consideration when calculating your long-term finances, so you can pay your tax bills on time. HMRC will fine your company if you file your return or pay your bill late. You can ask HMRC to reduce your payments on account, if you believe that your revenue for the next tax year will be significantly lower.
Tax rates
We should also note that as of the 2016/2017 tax year, your personal allowance is £11,000, so you will not pay income tax on this amount. After this, you will be taxed at the 20% basic income tax rate on revenue up to £32,000, the 40% higher income tax rate on income ranging from £32,001 and £150,000 and the 45% higher income tax rate for anything over £150,000. Therefore, for the 2016/2017 tax year, you could earn £43,000 before being required to pay the 40% rate.
National Insurance contributions
You will also have to pay national insurance contributions, which are calculated based on your firm’s earnings. There are two kinds of National Insurance contributions for sole traders. These are Class 2 (£2.80 per week, as of the 2016/2017 tax year) and Class 4, which is 9% of your firm’s earnings between £8,060 and £43,000 and 2% on any earnings eclipsing £43,000. In the 2015 budget, former-UK Chancellor George Osborne revealed that Class 2s will be eliminated for all self-employed workers during the next Parliament. As a sole trader, this could help you save a few extra pounds per week.
Value Added Tax
It is also important to note that if you firm’s turnover exceeds a certain threshold (£83,000 as of the 2016/2017 tax year), you will also need to register for Value Added Tax (VAT). After registering, you will need to include VAT in all your firm’s bills and you can reclaim any VAT you have paid on business expenses. It may be wise to register your firm for VAT even if your earnings sit below the current threshold, if most of your suppliers are businesses that you can reclaim VAT from.
Prepare for tax obligations
To prepare effectively for your firm’s tax obligations, it is vital that you keep accurate financial records, so you can calculate your tax bills efficiently. In order to keep more accurate records, as well as execute costly company transactions easily, you may wish to open a specialist business bank account. Turner Little can advise you both on the appropriate way to set up your business as well as on opening UK corporate bank accounts.
Turner Little
Turner Little was founded in 1998 and it has since become a well-established UK based professional Company Registration Agent, Registered Bank Intermediaries and Business Consultants, as well as Trust provider. You can receive our monthly newsletter by signing up using the form below.
