By Ian Marlow,
HfM Tax & Business Services Ltd., UK

info at hfmtax co uk
http://www.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.

Published - November 2010