Tax & admin · 19 March 2021

How much tax do I pay as a sole trader?

No doubt you have heard the advert say “Tax doesn’t have to be taxing”. You probably rolled your eyes like the other 3.5 million + sole traders in the UK. Tracking and strategically managing taxes is taxing because there is no magic wand solution.

Interestingly the Federation of Small Businesses (FSB) did a survey in 2018 on the amount of time dedicated to tax by small businesses. We were surprised by the result: the average businesses lose three working weeks every year to tax compliance! Yikes, that is longer than a lot of peoples’ annual leave.

The details behind the FSB’s survey showed that 45 hours were spent on VAT alone. Then 30 hours were spent on Pay as You Earn (PAYE), and 20 hours were spent sorting out employer National Insurance contributions. Finally, another 16 hours was spent on Income Tax, and, lastly, 15 hours were spent on Corporation Tax.

And that’s why it’s best left to the professionals who delight in it.

Other details showed that it costs firms, on average, £5,000 a year to collect data, keep records, file returns, make payments and liaise with the relevant tax authorities.

The FSB executives are not thrilled with these results and insist on small businesses, 59% of the total businesses in the UK, deserve a tax system that doesn’t drain them in more than one way.  It should be part of a solution that supports their growth and ambitions. They define the UK tax system as “undeniably complicated” (Martin McTague – Director – FSB).

As small businesses tend to be lean and keen, they don’t have baskets of resources to fling at complex calculations, and reporting processes like large, headcount-heavy, capital-rich conglomerates do.

How much tax do sole traders pay in the UK?

There is not a simple answer to this, but it will depend on a few factors. Firstly, it will depend on the structure that you have chosen for your business model. This plays a factor as different rules apply to sole traders and partnerships, and limited companies.

The next factor will be which industry your business is in. There might be industry-specific levies that apply and will, most likely, also be subject to their own qualifying factors.

Let us look at the different taxes that you will have to and might have to address as a Sole Trader.

Income Tax

Leading the admin pack and close to your heart will be Income Tax. If your accountant (yes, you benefit from having one of those) has shown benefits from being VAT registered, you will be tracking that. VAT can be collated by your accounting software system (yes, you benefit from having one of those too).

Next, if you have taken on headcount, you will need to track PAYE. Remember, if you have a contractor working for you with an employee-type relationship, you might need to redefine your legal relationship with them. Look up the relationship test set down in Ready Mixed Concrete (South East) Ltd v the Minister of Pensions and National Insurance [1968] 2 QB 467, which determined a four-stage test.

You will have to keep tight records on employees. The records must not only include how much you pay employees but also details of the deductions you make, written records of employee absences and reasons for absences, as well as the reports and the payments you make to HMRC.

Payments to your employees can range from salary to wages to tips, bonuses, Statutory Sick Pay, maternity pay, commissions, prizes, etc.

You are 100% liable to deduct tax and National Insurance for employees, including student loan repayments, company loan repayments and pension contributions.

Your report to HMRC must be detailed and have back up documents for any possible audits. It will include your employees’ payments and deductions on or before each payday. Luckily for all sole traders, there are a variety of online and hard drive software packages available to work out tax and National Insurance owings.

Corporation Tax

You are not liable for Corporation Tax unless you change from a Sole Trader to a limited corporation. If you do this change mid-tax year, you will have a partial submission under the sole trader structure and a partial submission under Corporation Tax.

If your business is in the building industry, there is a Construction Industry Scheme that applies. The principal contractors are obliged to deduct money from a subcontractor’s payments and pass it to HMRC.

This is because the deductions are advance payments towards the subcontractor’s tax and National Insurance (NI). The principal contractors are legally obliged to register for the scheme, whereas the subcontractors are not required to do so. The different types of work included in this scheme are the building of permanent structures, the building of temporary structures, demolition of buildings work, alterations and renovations to existing permanent or temporary structures, and system installations to buildings.

Another example of different rules applies if you are in the fishing industry. In particular, if you are:

  • not involved as a service employee,
  • nor a master or crew member of a British fishing boat operated by more than one person,
  • but get a share of the profits or gross earnings that have been earned from the activities of such a vessel.
You are then classified as a Share Fisherman, and, unfortunately, that comes with complicated tax arrangements. You are also a Share Fisherman if you used to be a crew member or master but are now handling shore activities. You must remember to register as a sole trader with the HMRC within three months of starting this Share Fishing relationship and register to pay NI Class 2. Annually you will do the Self-Assessment tax return and pay your NI contributions.

National insurance (NI) contributions qualify you for benefits and the State Pension subject to different classes of National Insurance which are calculated against earning factors and your situation at the time of applying.

If you are over 16 years old, are earning above £183 a week, are a sole trader and clearing £6,475 in profit each year, you will need to pay contributions.

Personal income tax (self-explanatory) is payable by every person earning income except for the first £1,000 of income from self-employment or property rental income. The final calculated amount due is affected by tax reliefs, pension contributions and charity donations.

VAT

If you have registered for VAT (with the HMRC), then the total of everything you sell has VAT calculated against it IF your total is more than £85,000. Some businesses do a voluntary registration despite their turnover being less than £85,000 because they benefit from the VAT input/output ratio, especially if you are buying predominantly from VAT-registered suppliers. If your customer base turns out to 100% corporate, they might demand that you register for VAT.

The VAT is obviously not charged on items that are legally exempt from VAT.

Due to the current economic situation which has arisen from the lockdowns of the Corona Virus COVID19 pandemic, you might pay less VAT if your work is based within the hospitality and tourism industry arenas. This reduction is temporary and subject to change so check with your accountant before allocating “spare” funds to other items.

There are varying VAT rules depending on industries and products, so check with HMRC or your accountant about your particular circumstances and make sure you are charging the correct rate and doing the correct submission calculations.

If you are about to change to a company structure, then you need to look at Corporation Tax. It is calculated on profits if you are a limited company, a foreign company with a UK office, or a club/co-operative or unincorporated association such as a sports club.

When you set up your company via Companies House, you will simultaneously register for Corporation Tax as part of the process. Everything legal has deadlines, and this needs to be done within three months of change from sole trader to limited company.

Your accounting records will include details of all incoming payments and outgoing payments for expenses spent by the company (not by you personally) and will also list assets, depreciation and debts.

There is a list of other financial records that will need to be prepared and filed with your annual accounts and company tax return. Your accountant (or bookkeeper) will be best to handle this finance document pack.

If you are a finance whizz kid, great, you can handle all of this on your own. Unfortunately, suppose you are not, and you fail to keep appropriate and relevant accounting records. In that case, you could face disqualification as a company director and also face receiving a non-negotiable fine of £3,000 by the HMRC.

Other taxes

Miscellaneous taxes are also due depending on which particular industry or industry segment your business will be operating in. Also, there may be levies or contributions that are required of your business. Make sure you know all of them.

If you are formalising your activities into a business in the casino gaming industry, are you aware that there is a Gaming Duty? This is to pay on casino gaming profits. You may feel you are exempt from this as your business model is online. Your assumption is incorrect as you are indeed responsible for the payment of a remote Gaming Duty.

On another note, are you aware that regardless of your business, if it gets rid of a lot of waste, you will be required to pay a Landfill Tax? Different Landfill Tax rates are affected by the factors of weight and the category that the waste has been assessed as.

Another tax that you might need to consider in your business is a tax on properties used for business purposes. Now you can understand why the FSB is complaining to the government about the complexity of taxes against businesses! This business property tax is charged on shops, offices, pubs, warehouses and factories.

Check if you’re eligible for a COVID19 pandemic business rates holiday from your local council. If you qualify, you must apply for the relief as it is not applied without receiving a request for relief.

And, yes, there are exemptions: agricultural land and agriculturally related buildings, buildings that are specifically used for training, and public religious worship sites (if they have been correctly registered as this).

Capital Gains Tax

When you sell all or part of an asset that is a part of your business and you, astutely, make a profit, you will be paying Capital Gains Tax. Relevant assets include land, buildings, goodwill, and registered trademarks but are not limited to this list.

This Capital Gains Tax will be paid by sole traders or those that are in a partnership. Corporation Tax on profits from selling assets will be paid if a limited company does the sale.  The “Capital Gain” is the difference between what was originally paid by you or by the business for the business asset and how much is received from its sale, even if it is a cash deal.

Of course, your accountant can advise you on legally permitted deductions from the profits such as an agent’s fee, a required fix to a fixture, improvements and renovations to the asset, including valuation fees and Stamp Duty Land Tax.

The last tax you will need to consider is if you are closing down your business. As a sole trader, it is, like most related things, much simpler. If you sell it at a profit, then a Capital Gains Tax of 10% should apply.

If you have changed to a limited company by the time you want to sell, then the best option is usually to sell shares in the company. This means that a Capital Gains Tax of 10% would be applicable. The liquidation of a company also attracts Capital Gains Tax.

If you are not selling but shutting down for good, then any funds taken out of the company by yourself for personal use might have Income Tax applied. Dividends could be taxed at 7.5%, 32.5%, or 38.1%, depending on the number of funds extracted.

How much can a sole trader earn and when is tax applied?

As you start out in your preliminary days as a new business, your first step would be to get a part-time bookkeeper. An experienced bookkeeper can deal with taxes while you grow your business.

You make better business if you focus on business strategy and operations whilst paying the experts to focus on admin and tax. Do what you do best – that’s an old saying that has stood the test of time.

For the 2020/21 tax year, the standard personal allowance, i.e. the amount that is not taxed, is £12,500. After this level of income, you start paying income tax. When you start earning over £100,000, the amount defined as “standard Personal Allowance” is reduced by £1 (from £12,500) for every £2 of income over £100,000 for the 2020/21 tax year.

Whichever tax you might or might not be paying, it is important to understand the rules and NOT ignore emails, posts, or electronic messages you receive from HMRC.

Ditching any or all the brown envelopes you receive does not solve anything. The requirements do not melt away into a dusty drawer. The problem grows and can cost penalties and interest.

If communications received are difficult to understand, your accountant can ‘translate’ it for you and explain the steps required. When you reply or take the required steps, you should be away from the repercussions of what you say and do. Yup, check with the accountant.

Your experienced accountant will be HMRC savvy and will have no problem navigating their system. Having an accountant on board will save you money in strategic tax management and penalty avoidance.

There is no limit to how much you are allowed to earn as a sole trader; HOWEVER, you will probably pay more tax if you are a big earning sole trader versus a company structure. It is also better from a customer perspective if you are a company whose turnover is substantial versus sole trader status.

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