In this section we take a quick look at how to work out what level of profits you will need to include in your self assessment tax return and what expenses & capital allowances you can deduct from those profits.

If you need information about selling items online on sites such as Ebay, through classified advertisements and at car boot sales you may find it useful to look at the HMRC Guide for people who sell items online, through classified advertisements and at car boot sales as to whether or not you will be trading and if so what to do next. They also have a useful section on this topic under the heading of Conditions for e trader status.

The topics covered are:

Starting your own business - registering for tax and NIC

Pre-trading expenses

How do I work out my taxable profits?

Which business expenses are allowable?

Capital allowances

Starting your own business - registering for tax and NIC

• You've decided to work for yourself - firstly you need to make sure that you are actually going to be self employed as the Revenue will need to be happy that this is the case and that you are not in fact an employee instead.



• So have a look at the section of the website which is intended to help you work out what makes someone employed and what makes someone self employed for working out tax and National Insurance. Use the link here to check this out.



• Secondly - one of the first things to do when you start trading is to notify HM Revenue & Customs.



• You can do this when you start your business if you want but in any case you must have registered within the first three months of trading. You will need to do this even if you already send in a self assessment tax return.



• The Revenue can charge penalties if you do not register so you should deal with this as a priority once you decide to become self employed. The penalty for failing to register for Class 2 NIC is £100. A penalty may be waived if there is reasonable excuse for the delay or the Revenue Board allow more time.



• The time limit for registering for Class 2 NIC is a little confusing! Basically the Revenue can charge a penalty on the day following the end of the calendar month falling three months from the end of the month you started in business. We can see this more easily in a couple of examples - if you started in business on 15 September 2010 - the end of your first month is 30 September 2010 - three months later is 31 December 2010 - the penalty can be charged from 1 January 2011. If you started in business on 3 March 2011 - the end of your first month is 31 March 2011 - three months later is 30 June 2011 - the penalty can be charged from 1 July 2011. Have a look at our article on this - The newly self employed and National Insurance.



• You need to register even if you are going to defer Class 2 NIC (because you are both employed and self employed)



• If your profits are low enough so that you can obtain a Small Earnings Exception Certificate which means you will not need to pay any Class 2 NIC, you will need to apply for this immediately if you want to avoid a penalty being charged before you become excepted. However you must still register even if your earnings are low enough for a SEE certificate but you will not then have to pay a penalty if your registration is late.



• You can see the benefits that your Class 2 NI contributions will entitle you to by clicking here.



• You will also need to let the Jobcentre know when you start working for yourself if you are currently unemployed.



• The Revenue have a useful leaflet which also contains the forms you will need to complete in order to register your business. This is SE1 - Are you thinking of working for yourself



• The main form you need to complete is CWF1 which as we mentioned above is also in leaflet SE1. The Revenue do have a facility for completing the form online but this is not currently functioning. Alternatively you can phone the Helpline for the Newly Self-Employed on 08459 15 45 15 and complete the form over the phone.



• If you expect to have to register for VAT there is a box you need to tick on the form. You can find more information on VAT from this website by clicking here and from the HMRC website.



• Leaflet SE1 also include an application to pay Class 2 NIC by direct debit.



• Another useful Revenue publication for anyone starting up in business for themselves is: Working for yourself - The Guide and Business Link have The No-Nonsense Guide to Starting a Business which is also very informative and covers a lot of other areas apart from tax. Links to Business link equivalents for Scotland, Wales and N Ireland can be found here.
• Additionally you can find more information from the Revenue Starting up in business pages which can be found here . This page also includes a link to the Revenue Business Support Team - you can arrange to see an adviser from the team for more information and advice once the business has started.



• New employers can get help on payroll matters from the Revenue helpline on 0845 60 70 143.

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Pre-trading expenses

• The general rule is that you can deduct trading expenditure from profits when it is made and so is not allowable if incurred before trading starts.
• The rule is relaxed for some pre-trading capital expenditure. It is necessary to treat expenditure incurred before a qualifying business begins as being made on the first day you carried on the business. So if Fred decides to start trading as a self employed carpenter and he buys some tools on 1 October 2010 and starts the business on 1 January 2011 - he will be treated as incurring the expenditure on the tools on 1 January 2011.
• There is also some relief available for expenditure made within the seven years before you start in business which, had it been incurred on the first day of trading, would have been deductible in working out your profits. The expenditure is treated as if you made it on the on the first day of trading and will be included in your first accounts. Expenditure which would normally be allowed in your accounts e.g. pre-trading purchases of stock or advance payments of rent, is not within this special relief.



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How do I work out my taxable profits?

Your accounting date

• You can have any day in the year as your accounting date although for working out your tax 31 March or 5 April are the easiest dates.



• If your accounting date falls between 31 March and 4 April - you can treat these dates as if they were instead 5 April as this makes working out your tax much easier.



• You can however choose whatever date is most suitable to your business. If your business is seasonal you may want a date in your low season or when trade is usually slow.



• You may have other reasons for the date you choose or you may just use the anniversary of your start date if you prefer.



• You normally keep the same date each year although you can change the date if you want. However to make your tax simple it is better to keep the same date as far as possible.



• If you make up your accounts to 31 December each year, this is your accounting date and the 12 months to December are your accounting period.




Your basis period

• Apart from your first few years of business and any year in which you change your accounting date - your basis period for any tax year is usually the 12 months up to your accounting date ending in that tax year.




So for example if you have been in business for a few years and your accounting date is 31 January - your basis period for 2010/11 (the year to 5 April 2011) will be the twelve months ended on 31 January 2011 as this is the end of the accounting period falling in the tax year.




• If instead you made up your accounts to 30 September 2010 - these accounts would also form your basis period for 2010/11 as your accounting date falls within that tax year.




In your first year




First tax year

• If you started business during 2010/11, your basis period for the first year will be from the date you started to 5 April 2011.




You started business 1 July 2010. Your basis period for 2010/11 will be 1 July 2010 to 5 April 2011.





Second tax year



• If your accounting date falling in this tax year is 12 months or more after the date you started your business - your basis period will be the 12 months to your accounting date.




You started business on 1 June 2009. If your accounting date is 31 August - your basis period for 2010/11 will be 1 September 2009 to 31 August 2010.




• If your accounting period ending in 2010/11 is less than 12 months - your basis period for the year is 12 months beginning on the date you started.




You started business on 1 June 2009. If your accounting date is 31 March - your basis period for 2010/11 will be 1 June 2009 to 31 May 2010.




• If you do not have an accounting date in 2010/11, your basis period for that tax year is 6 April 2010 to 5 April 2011.




You started business on 1 February 2010. Your first accounts end on 31 May 2011. There is no accounting date in 2010/11 and so your basis period for that year will be 6 April 2010 to 5 April 2011.





In your last year



• If you cease your business in 2010/11(between 6 April 2010 and 5 April 2011), your basis period will be from the end of the basis period for 2009/10 up to the date you finished your business. You will get some overlap relief so that you are only taxed on 12 months profits in total.



• This is easier to see in an example.




Your business stopped trading on 31 March 2011. You normally have an accounting date of 30 September so for the previous tax year 2009/10 (6 April 2009-5 April 2010) your accounting date would have been 30 September 2009. For your final year 2010/11 your basis period is therefore 1 October 2009 to 31 March 2011.





Changing your accounting date

• If you want to change your accounting date for tax purposes you will need to explain to the Revenue in your tax return why the change is necessary.



• They may not accept your explanation in which case you will have to keep your existing date. However if you have a reasonable argument it is likely to be accepted e.g. you have 2 businesses and you want the same accounting date for each. You cannot just keep changing the date each year to suit yourself.



• For the tax year first affected by the change, you will also need to have sent your tax return to the Revenue before the filing date of 31 January following the end of the tax year or the change will not count.



• If you want the change to be temporary - you can ignore it for tax purposes.



• Otherwise:
• If you have made up your accounts to a date different from that used for your tax last year or;
• If you intend to draw up a set of accounts for more than 12 months so that no accounting date falls into the current tax year or;
• If you changed your accounting date last year but this was not accepted by the Revenue and you are using the same date again

- You will be treated as having changed your accounting date.



There are 2 rules for working out your new basis period:

• If your new accounting date in 2010/11 is more than 12 months after the end of your basis period for the previous year 2009/10 your new basis period will be from the end of that basis period to your new accounting date.



• You will get some overlap relief so that you are only taxed on 12 months profits in total.




If your basis period for 2009/10 ended on 30 June 2009 and the new accounting date is 30 September 2010, your basis period for 2010/11 is the 15 months - 1 July 2009 - 30 September 2010.




• If your accounting date in 2010/11 is less than 12 months after the end of your basis period for the previous year to 2009/10 your new basis period will be 12 months ended on the new accounting date.




If your basis period for 2009/10 ended on 30 September 2009 and the new accounting date is 30 June 2010, your basis period for 2010/11 is the 12 months to 30 June 2010.




When you have more than one set of accounts for a tax year




• When you start in business you may find you have more than one set of accounts, which come within your basis period. When this is the case you need to work out what part of each set of accounts comes within the basis period and add the figures together.




For example if you started in business on 6 April 2010 - your basis period is the 12 months to 5 April 2011. Your accounts are made up for the 4 months to 31 July 2010 (profit £5,000) and the 12 months to 31 July 2011 (profit £12,000). You can therefore work out the profits to be taxed as the basis period for 2010/11: £ 4 months to 31 July 2010 5,000 8 months to 5 April 2011 (8/12 x £12,000) 8,000 £ 13,000





Overlap relief

• When you start up in business or when you have a change of accounting date you can have some profits that will end up being taxed twice because their basis periods overlap.
• When this happens you should keep a note of the amount of the overlap profit and what number of months it relates to.




Your business started on 1 February 2010 and your first accounting period is for the 12 months to 31 January 2011. Looking at your basis periods: 2009/10 1 February 2010 to 5 April 2010 2010/11 1 February 2010 to 31 January 2011 The period of overlap is from 1 February 2010 - 5 April 2010. So if the profit for the 12 months is £10,000 the amount of overlap relief is 66/366 x £10,000 = £1,776.





• You carry your overlap profit forward in box 3.80 on your tax return until such time as you change your accounting date or the business ends when you may be able to use it.
• You can use all your overlap profits still brought forward when your business ends or if you change your accounting date and your basis period is more than 12 months, you can use your overlap profits to reduce the basis period to 12 months. This is easier to see in the next example.




You have unused overlap profit of £6,000 which came about because 6 months of profits overlapped when you started your business. You then change your accounting date and your new basis period for 2010/11 is 15 months. You can only be taxed on 12 months profits. You have 6 months overlap relief available and you need to reduce the 15-month basis period to 12 months so you use 3 months of your relief up. Overlap relief used 3/6 x £6,000 = £3,000 Your profits for 2009/10, which are based on a 15-month basis period will be reduced by £3,000 and you still have 3 months overlap profits to carry forward.



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Which business expenses are allowable?

If your annual turnover in your business is less than £15,000 you need only enter the total figure of your business expenses in the Self-employment short version Supplementary Pages SA103S. However make sure you keep details of the expenses you claim in case the Revenue make enquiries into your tax return.

You can use the short return if your turnover is under the VAT threshold currently £70,000 (2010/11) and provided certain other circumstances do not apply. Have a look here for the full list. Otherwise you will need to complete the self-employment full version supplementary pages.

If your annual turnover in your business is less than £15,000 but you because of your circumstances you will still have to complete the full self employed pages you need only enter the total figure of your business expenses in box 3.25. However make sure you keep details of the expenses you claim in case the Revenue make enquiries into your tax return.

If your annual turnover is more than £15,000 you will need to show your actual expenses in boxes 3.30 - 3.63 of the supplementary pages.

Looking at SEF2 of the self employed pages you can see that there are two columns for each expense - the right hand column is where you will include the total expenses or costs and the left hand column is for any amounts that are not allowed but are included in the total in the right hand column.

The disallowable expenses in boxes 3.30 - 3.45 should be totalled and included in box 3.66.

There are two useful tables showing which expenses are allowable and which are disallowable at pages SEFN 6 and SEFN7 of the self assessment self employed pages notes.

We have a more detailed look next at which types of expenses are allowable and which are not.


Costs of sales (boxes 3.30 & 3.46)

Generally allowed expenses:


• At the end of your accounting period you will normally have a stock take if you are a manufacturer or a retailer of goods.



• Your stock is valued at its cost to you or the amount you would get if you sold it whichever is the lower. You will need to include any work in progress and raw materials you have received but not yet paid for.



• To work out your cost of sales
  
  
  • Take your stock value and that of any work in progress at the start of the period and;
  • add: any raw materials you have bought during the period and;
  • deduct: what remains at the end of the period



• If you are a taxi or haulage driver the Revenue say you should enter fuel costs in box 3.46 rather than elsewhere unless you are claiming mileage rate.



• If your business provides services rather than goods, you would make a similar adjustment to your work in progress to reflect any increase or decrease during the period.


Generally disallowed expenses:



Fuel expenses for non-business use of vehicles


Construction industry subcontractor costs (boxes 3.31 & 3.47)

Generally allowed expenses:



All payments to subcontractors in the construction industry. If any payments have been made to uncertificated contractors use the amount before any tax deductions.

Generally disallowed expenses:

Any non-business payments

Other direct costs (boxes 3.32 & 3.48)

Generally allowed expenses:


• Any expenses you took off to get to your gross profit for example - discount allowed, commissions payable or carriage



• If you are a manufacturer of goods - the costs of producing the goods you sell such as direct labour costs, machine hire, depreciation of fixed plant, small tools etc.



• If you provide services you may have rechargeable expenses you can deduct from your gross profit


Generally disallowed expenses:

Depreciation (this is a percentage taken off the original cost each year based on wear from use or age) of fixed plant

Employee costs (boxes 3.33 & 3.51)

Generally allowed expenses:


• Wages & salaries including bonuses, commissions and overtime paid to your employees whether permanent, temporary or just casual labour



• Employer's National Insurance Contributions (NIC)



• Pension contributions and insurance costs



• Wages costs (including NIC) of employing your wife or husband or another member of your family provided that they do genuinely work for the business and their pay (which must be within the national minimum wage) is reasonable for the amount of work they do



• Staff entertaining costs - for example the staff Christmas party



• Other staff related costs such as canteen expenses and recruitment agency fees



• Costs of subcontract labour or a substitute/locum to stand in and do the work for you if necessary



• Employee training costs and any fringe benefits


Generally disallowed expenses:


• Your own wages, salary or drawings you take out of the business, your National Insurance or pension payments or other benefits.



• Employees wages remaining unpaid nine months after your accounting date - these will be allowed once they are actually paid



• Any excessive wages paid to family members - you can claim as allowable what is reasonable for the actual work they do.


Premises costs (boxes 3.34 & 3.52)

Generally allowed expenses:



If you have an office outside your home - you can include any rent, business rates, water rates, lighting, heating or power, property insurance and security costs, office cleaning, any repairs and maintenance to the office premises but not any improvements. If you lease your office premises and the lease is for less than 50 years you should be able to claim part of the premium you pay.

Use of home as office

• If you use your home as your office - you can claim part of your mortgage cost only if you use that room or rooms exclusively for business.



• You can also claim a proportion of your home related expenses such as heating, lighting, power, maintenance, cleaning and Council Tax. There is no hard and fast rule about claiming for use of home as office. As a concession the Revenue are usually prepared to accept a modest amount of between £1-5 per week in lieu of a claim for specific expenses.



• Bear in mind the proportion of any expense claimed should be based on the total rooms in the house and the number you use for business. You should work out the number of rooms in your house - excluding bathrooms and cloakrooms or smaller kitchens and apportion the total expenses between rooms used for business and those used for private use.
  
  For example say there are ten rooms in your house and you use one for business - you could claim a tenth of the total expenses for the year.



• You should be aware though that there is no certainty the Revenue will accept your figures and it may be simplest to work out the claim on this basis for the first year and when you send in your return, include an explanation of how you worked out the expense in the additional information box on page 4 of the supplementary pages.
  
  If the Revenue agree with this method of working out the deduction, you can use the same basis for later years or if not you may be able to come to some compromise figure between you.



• The fact that you are using your home for business could strictly mean that you might be liable for Capital Gains Tax when you sell your home. Similarly, if you claim for part of your Council Tax or mortgage payments this might also have the same effect. However if the claim is fairly modest there should not be an issue with this.
  
  Generally you can prevent the problem arising provided you do not use any one room in your house exclusively for business. For example if you work in your spare bedroom, which is also used as a guest bedroom this should normally be sufficient.
  
  Again this is a grey area and the above information can only be given as guidance not hard and fast advice. If you do feel that there might be an issue you may want to discuss your own situation with the Revenue.




Generally disallowed expenses:

• The cost of buying your business premises



• Any costs relating to that part of your business office not used for work.


Repairs (boxes 3.35 & 3.53)

Generally allowed expenses:



Any general renewals, repairs and maintenance to your office premises, fixtures and machinery and the cost of replacing small tools.

Generally disallowed expenses:


• The costs of any improvements or major alterations to your office or business premises.



• Any non-business part of the cost of repairs and maintenance to your premises or machinery.



• Any general reserve you keep for repairs


General administrative expenses (boxes 3.36 & 3.54)

Generally allowed expenses:


• Typical office expenses such as telephone, fax, postage, stationery and printing, costs of trade or professional journals and subscriptions, courier services, general office expenses, costs of insurance not included elsewhere, together with any other similar recurring costs which arise in running the business.



• Cost of computer software you use in your business which you obtain under a regular licence fee and in addition any computer software with a limited lifetime of generally less than 2 years. Any other software is usually capital expenditure on which you can claim capital allowances.


Generally disallowed expenses:


• Any non-business part of your general expenses



• Any personal expenses



• Payments to political parties



• Most donations and fees made to clubs, charities or churches.


Motor expenses (boxes 3.37 & 3.55)

Generally allowed expenses:



Business element only of the motor expenses incurred in running a vehicle used in your business including insurance, servicing, repairs, road tax, fuel, hire and leasing charges, parking charges (but not parking fines), membership of the AA or RAC or similar

Generally disallowed expenses:

• Any non-business motor expenses



• Travel between your home and business



• Cost of buying vehicles for your business (but you can claim capital allowances. instead)



• Parking and other fines


Travel & subsistence (boxes 3.38 & 3.56)

Generally allowed expenses:



Hotel accommodation, air, rail or taxi fares, meals connected to your overnight stay whether included in your hotel charge or separate, additional subsistence expenses such as expenditure on meals where your work involves substantial travelling or where you need to make one-off journeys that are not part of your normal business activities.

Generally disallowed expenses:

Costs of most meals apart from those mentioned above


Advertising, promotion and entertainment (boxes 3.39 & 3.57)

Generally allowed expenses:


• Every day costs of advertising and promoting your business goods or services - for example newspaper advertising, mail-shots, free samples, gifts up to £50 per year to a customer. The gift must prominently advertise or promote your business or services and excludes food, drink or tobacco.



• Staff entertaining unless this arises as part of business hospitality - if a member of staff takes a customer to lunch this is business entertaining and is disallowable.




Generally disallowed expenses:

• Entertaining & hospitality apart from the costs of entertaining staff



• Gifts of more than £50 per year to customers (see generally allowable expenses)


Legal & professional (boxes 3.40 & 3.58)

Generally allowed expenses:


• Fees charged by accountants, solicitors, surveyors, architects, stock takers and other similar costs. The accountants fees can include the costs of dealing with a Revenue enquiry provided there is no fraud or negligence involved)



• Debt recovery costs




Generally disallowed expenses:

• The legal expenses involved in buying premises or equipment as these are treated as part of their cost. If capital allowances can be claimed on the expenditure these legal costs are included in the total spend on the asset involved.



• Costs of settling tax disputes



• Costs and fines for breaking the law or any other illegal acts



• Legal expenses on the formation of a company



• Fee insurance protection (if it would cover your professional costs in the event of fraud or negligence)


Bad debts (boxes 3.41 & 3.59)

Generally allowed expenses:


• You no longer expect to be paid for goods you have sold or services provided which are included in your turnover but remain unpaid at the end of the accounting year and you decide to write off the amount involved



• If you do recover the written off amount in a later year you will need to show the amount you receive in box 3.50 (other income or profits)



• Part of a bad debt given up under a voluntary arrangement




Generally disallowed expenses:

• General bad debt reserve



• Debts untaxed when they arose because they related to the sale of a fixed asset (e.g. equipment, machinery etc.)


Interest (boxes 3.42 & 3.60)

Generally allowed expenses:



Interest on a business overdraft or loan from a bank or other lender including any arrangement fees involved

Generally disallowed expenses:

Any part of the repayment of the loan or overdraft which is a refund of the capital


Other finance charges (boxes 3.43 & 3.61)

Generally allowed expenses:


• Business current account charges



• Credit card charges and fees



• Hire purchase interest (but not any capital repayments)



• Leasing payments (in the case of cars this is limited in the case of a car costing over £12,000 when new unless it is considered to be environmentally friendly)



• Similar costs not included elsewhere




Generally disallowed expenses:

Any part of the repayment which is a refund of the capital


Depreciation and loss/(profit) on sale (boxes 3.44 & 3.62)


• Add together:
  Depreciation
  Loss on sales of assets
  Then take off:
  Profit on sales of assets



• Put the resulting total in box 3.62



• If the profit on sale if more than depreciation and any losses added together put the figure in box 3.62 in brackets e.g. If depreciation is £1,000 and loss on sale of assets is nil but the profit on sale is £2,500 you will need to show (1,500) in box 3.62. This amount will then be taken off when you add up all your total expenses.



• Whatever figure you put in box 3.62 you should put the same figure in box 3.44 unless some of the costs relate to finance leases. if this is the case you should get advice from the Revenue as to what you should include.



• The reason for doing this is that generally depreciation and losses on assets are not allowable for tax and any profit on sale of an asset is not taxable (unless you are liable to capital gain on the profit) so by putting the same figure in each box you simply cancel them out. Generally instead you would claim capital allowances on the asset so on sale you will get a balancing allowance or balancing charge.


Other expenses (boxes 3.45 & 3.63)



Generally allowed expenses:

• Any expenses which you cannot include in boxes 3.46 - 3.62.



• This might include:
  
  
  • Subscriptions to relevant trade and professional associations
  
  
  
  • Contributions to business link organisations, local enterprise agencies, training (including local) and enterprise councils, and similar
  
  
  
  • Pre trading expenditure - allowable expenses that are treated as if incurred on the date you start trading
  
  
  
  • Research & development costs related to a trade but not a profession and it excludes any costs of acquiring rights to research but you may be able to claim capital allowances instead.
  
  
  
  • Your own training costs if these improve your existing knowledge and skills and are wholly and exclusively for business purposes. If the course is to provide you with new skills it is disallowable.




Generally disallowed expenses:

• Non business element of any expenses in box 3.63



• Cost of any ordinary clothes you buy even if you only use them for work



• Cost of computer equipment and software if not allowable at box 3.54 (you may be able to claim capital allowances on some items)