In this blog post we will have a brief overview of what bookkeeping is, introduce you to the requirements for self-employment and some key terminology, we will look at financial record keeping, VAT and self-assessments for businesses in the UK.
There are different types of self-employment. A sole trader is a one-man band. A sole trader works by themselves and keeps any after tax profits and is personally responsible for all business-related debts.
A partnership is when two or more people share responsibility of a business, and the responsibility of business debts is shared.
A private limited company is its own legal entity and will need a director of the business. The director isn’t financially responsible for any business debts, but a limited company has to pay corporation tax on any profits. The annual accounts must be submitted to companies house and are made available for public viewing.
A limited liability partnership is like a limited company, but it must have at least two shareholders.
What is bookkeeping?
Bookkeeping is the first stage of the accounting process. Bookkeeping involves creating records of all financial transactions and organising the records to create daily or weekly reports. There are different methods of bookkeeping but for a small business or sole trader, one of the easier ways is to use cash basis reporting whereby you are recording monies coming in and monies going out. This means you can track your cash flow and balance your books.
The GOV.UK website is a useful resource for finding out what records need to be kept.
Cash basis reporting
‘Cash basis reporting’ is a way to work out your income and expenses for your Self-Assessment tax return, if you’re a sole trader or partnership and have a turnover of £150,000 or less a year. Turnover means the amount of money a business has taken in, before taking off any expenses. The key advantage of the cash method is its simplicity because it only accounts for cash paid or received. It isn’t the only methods of accounting but it is very simple because all you are required to do is work out your taxable profit from your cash basis income and expenses records, at the end of the tax year. The tax year starts on 6th April and ends on the 5th April the following year. For example, the tax year for 2020 started on 6th April 2020 and ended on 5th April 2021.
For healthy financial record keeping, you need to record the business’s total income and total expenses on a daily basis and simply add it all up for your end of year report. If you do submit your self-assessment using this method, you must tick the cash basis box on the form when you send your return.
What is a self-assessment tax return?
Self-Assessment is a system HM Revenue and Customs (HMRC) uses to collect Income Tax. You can submit it yourself or you can pay a bookkeeper or accountant to do it for you. You would need to give them access to your financial records for that tax year.
Everyone is entitled to a personal allowance which is the amount you are allowed to earn before you have to pay income tax. In 2023, the personal allowance was £12 570 so individuals only paid income tax on any money your earned on top of that. For example, if, as a sole trader, after expenses you earned £18 000, your taxable income would be £5430.
There are different tax bands and for income between £12,571 and £50,270 you pay the basic rate of 20%. For income between £50,271 to £125,140 you pay 40%. HMRC will calculate your income tax bill based on what you tell them in your self-assessment. You must pay your income tax bill by midnight on 31st January the following year. So, for the 20/21 tax year that ended on 5th April 2021, sole traders had to submit their self-assessment and pay their income tax bill by 31st January 2022 or you may incur a penalty.
Key terminology
NIC stands for national insurance contributions. Self-employed people pay Class 2 and Class 4 National Insurance if they’re 16 or over and making a profit of more than £12,570 a year.
UTRN stands for unique tax-payer reference number they are 10-digit codes that uniquely identify you or your business. They're used by HMRC whenever they're dealing with your tax. You get one automatically when you apply for self-assessment.
An SA100 is the main self-assessment tax return form.
MTD stands for making tax digital and is a government initiative for self-employed sole traders, landlords and others who currently report taxable income of more than £50,000 a year via Self-Assessment. The government created this initiative to make it easier for small businesses to do their tax returns and to prevent basic errors. In December 2022 the government announced that they had pushed back the deadline to 2026.
“Payment on account” are tax payments made in advance towards your tax bill, twice a year, if you pay most of your tax through Self-Assessment. These are usually due by midnight on the 31st of January and the 31st of July every year.
Capital allowances are a way of obtaining tax relief on some types of capital expenditure. They are treated as another business expense and so reduce your taxable profit within your basis period.
VAT registered
Businesses have to register for VAT if their VAT taxable turnover is more than £85,000. They can also choose to register if their turnover is less than £85,000. VAT registered businesses add VAT to the sale price of goods and services they sell to both commercial and non-commercial consumers.
HMRC require you to keep your records for at least 5 years after the 31 January submission deadline of the relevant tax year.
If you do decide to start working for yourself and go on to earn more than £1000 through self-employment, you must inform HMRC by 5th October in your second tax year. You can do this by registering for an online account with gov.uk and registering for self-assessment. You still need to register for self-assessment if your main job is through employment but you earn more than £1000 on the side by working for yourself part-time.
To learn more about allowable expenses and to download a free template for keeping cash basis records, purchase our business management course and complete the bookkeeping lesson.
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