How Self-Employed Can Reduce Their Tax Liability
By Ian Marlow,
HfM Tax & Business Services Ltd., UK
info at hfmtax co uk
Self-employed taxpayers are taxed on their profits, whether or
not they take the profits and spend them or plough them back into
the business. Unlike a limited company, therefore, there are fewer
opportunities for tax planning, but that's not to say that tax savings
are not possible. Here are some ideas:
1. 'Think Business' for Expenses.
Many self-employed business owners throw money away by not keeping
enough receipts. It's not sophisticated tax planning, but the more
expenses that you are able to record, the lower your profits and
the less tax you are liable to pay. You simply need to train yourself
to do two things every time you buy something. First you need to
think whether what you are spending is really a business expense.
It is if it is 'wholly and exclusively in the course of your business'.
What that means depends upon the business you run. If you are a
plumber, then a wrench would qualify; if a university lecturer,
then books to research for a journal article. A legitimate expense
will therefore vary from business to business so it pays to stop
and think whether what you are about to purchase is directly related
to your business. The problem when you start a business is that
you may well already be in the habit of buying such items. But you
are the owner of a business now and you need to think like one.
Secondly, you need to ask for, and then, keep the receipt as evidence
of the purchase. If you don't keep a record you are likely to forget
the purchase and consequently pay more tax. Training yourself to
think and keep receipts will always save you money in the end.
2. Make Sure You Use the Annual Investment Allowance.
Purchasing equipment is not dealt with in your accounts in the same
way as buying other expenses. Equipment such as a car or computer
is depreciated according to the rules for capital allowances. So,
instead of being offset against the income in the year in which
the expense is incurred, the cost is spread over the estimated life
of the asset. The rules for doing this tend to change quite regularly
and it's easy to be caught out by changes unless you have professional
advice. Currently, it is possible to claim the first £100,000 of
capital expenses (apart from cars and buildings) as Annual Investment
Allowance (AIA) and depreciate it all in the year of purchase, any
more than that being depreciated at 20% per year as a reducing balance.
Next year the AIA reduces by half and we don't yet know what will
happen after that, though it is likely to be less beneficial. So,
if you are thinking of buying a large capital item, then this year
would be a good time to do it in order to reduce your tax liability.
3. Think About Registering for the Flat Rate VAT Scheme.
If you are VAT registered and have limited expenses on which to
reclaim VAT, then it may be worth you simplifying your VAT-related
administration by registering for the VAT Flat Rate Scheme (FRS).
Under the FRS you pay a fixed percentage of your turnover to HMRC
rather than calculating the difference between the output and the
input VAT. Each business category has a different percentage attached
to it. You need to be clear though that the percentage relates to
the total invoicing; that is the amount you charge plus VAT at the
appropriate rate. As well as saving in administration, this can
give rise to a tax gain if your expenses are particularly low. If
you end up paying less VAT using FRS than you would be liable otherwise,
then you can keep the difference, though it does becomes taxable
as income. Any tax saving would probably not be the main motivation
for registering for FRS but it may be a welcome additional benefit.
4. Claim for Use of Home as an Office.
Many business owners start their business from a spare room and
for some the business is able to grow without needing to relocate
to separate offices. If you do work from home you should definitely
make a claim for the use of your home as an office. Often people
do not do this because they are not sure what constitutes an appropriate
claim and that is understandable because this can be a complex and
confusing area. In general HMRC will allow an allowance of £3 per
week for using your home as an office. This is an accepted amount
to claim for employed workers who are required to do some work from
home and, for some types of self-employment where only incidental
administration is carried out at home, this may be all that is sensible
to claim. On the other hand, if you use a room mainly for business
purposes, most days then it becomes reasonable to claim an appropriate
percentage (by the number of rooms used or by floor area) of home
expenses as a business cost in order to reduce your profit. I do
recommend getting some professional advice on this as your advisor
will have wide experience of how HMRC view different situations
and can advise you on the risks and benefits of different approaches.
They will also be able to warn you about the potential Capital Gains
Tax traps so that you can avoid them.
These are by no means all of the ways in which the self-employed
can reduce their tax liability, but hopefully this article has begun
to point you in the right direction and encouraged you to think
harder about your situation and encouraged you to do some more research.
Ian Marlow runs HFM, a London
tax and accounting business serving clients who are resident in,
and living outside, the UK. For more detailed tax information and
access to their excellent free monthly tax newsletter, go to the HFM
website => http://www.hfmtax.co.uk
Published - November 2010