SELF-EMPLOYMENT

Is it a trade?

Usually, it will be obvious if your new activity is a trading business or not. If you’re selling goods or providing services with a view to making a profit, you’re trading. However, if you occasionally make a bit of money from a hobby, you’re unlikely to be trading. The intention you have will carry a lot of weight if you need to argue that a trade doesn’t exist (or that one does exist!) later on. 

 

Why would I want to argue that a trade exists? 

It might seem that only HMRC would benefit from the existence of a trade, but the rules work both ways. For example, if you make a profit from trading you’ll have to pay tax on it, but equally a loss can be used to reduce the tax on your other income. As you can deduct trade-related expenses (including pre-trading expenses, subject to a number of conditions), loss relief can be very valuable. Not surprisingly, HMRC is keener to argue that a profitable activity is a trade than a loss-making one in borderline cases. 

Case Study: Mr Patel 

In Patel v HMRC [2015] TC04225, Mr Patel (P) started two “businesses”, neither of which made a profit. P claimed income tax relief for the losses. HMRC challenged P’s claim at a tribunal because in its view it related to non-business transactions and so was a personal financial loss and not one arising from a trade. Non-trading losses can’t be set against taxable income and it’s not just HMRC being awkward. 

Because, in the tribunal’s view, P was inexperienced and couldn’t devote enough time to them, neither venture was capable of making a profit without P reducing the hours he spent in his main job. In essence, P didn’t have the business acumen or time to devote to making his business profitable. 

The ruling in P’s case is useful, not just for guidance on when losses are deductible, but for countering HMRC if it claims money you make from a hobby is taxable. Its view has always been that if you advertise your hobby in a newspaper or online you’re probably trading. But the tribunal’s judgment, supported by HMRC, dispelled that idea. If you don’t have the time or intention to carry on a trade, profit you make from isolated sales isn’t liable to income tax. 

If no trade exists, you need to consider whether capital gains tax could apply.

 

Is there a test to see if I’m trading? 

There is no straightforward test. Over the years the tax tribunals and higher courts have considered the meaning of “trading”, leading to the so-called “badges of trade”. In summary: 

Profit-seeking motive 

An intention to make a profit suggests trading, but it is not conclusive by itself. 

The number of transactions 

Systematic and repeated transactions, i.e. buying and selling frequently, indicate a trade. 

The nature of the asset 

If assets are used to sell for a financial gain only this indicates a trade. However, where they are used to generate income or for personal benefit, e.g. buying vintage cars and selling them after a lengthy period of ownership, this indicates a non-trading motive for ownership. 

Existence of similar trading transactions or interests 

Transactions that are similar to those of an existing trade imply trading. 

Changes to the asset 

If assets are repaired, modified or improved to make them more easily saleable or saleable at a greater profit this suggests a trade. 

The way the sale was carried out 

If assets are sold in a way that was typical of trading organisations, e.g. via an online shop, this indicates trading. 

The source of finance 

If money was borrowed to buy the assets sold with the intention to repay the loan from sale proceeds, this indicates a trade unless ownership of the assets was an investment or for personal enjoyment. 

Interval of time between purchase and sale 

Trading assets will normally, but not always, be sold quickly after acquisition. Therefore, an intention to resell an asset shortly after purchase will indicate trading. However, an asset which is to be held indefinitely is much less likely to be a subject of trade. 

Method of acquisition 

An asset that is acquired by inheritance, or as a gift, is unlikely to be the subject of trade. 

All the badges will not be present in every situation. Some of those that are may point one way and some the other. The presence or absence of a particular badge is unlikely to provide a conclusive answer to the question of whether or not there is a trade. 

 

I want to start trading - what do I need to know? 

Trading profits are chargeable to income tax, and trading losses can be relieved to reduce your tax bill. We will look at how to work out your profits (or losses), but first it’s worth considering whether any relief is available for costs you have already incurred. 

The first key tax date for any business is that on which it opens its doors to customers (literally or figuratively). HMRC refers to this as the date on which trade commences. It’s important because it’s the point from which HMRC starts to measure the profits and losses on which you’ll pay income tax and NI. 

However, no business starts overnight. At the very least you must decide what to call your business, make agreements with business partners as well as taking practical steps, such as setting up a bank account and a means of getting paid by your customers. The lead-in time for getting a business ready to trade can vary significantly; it might be just a few days if you’re setting yourself up as a consultant and working for just a few clients you already know, or it can last months if you’re starting a manufacturing business requiring premises and the installation of heavy machinery. 

It’s likely that every business will incur expenses before its trade commences. Without special rules some of these might not qualify for a tax deduction. 

The rules for pre-trading expenses allows you to claim a tax deduction for costs relating to your business if they would have qualified for a deduction had you incurred the expense after trading commenced. The rule says that pre-trading expenses are treated as if they were incurred on the first day business commences. You can look back seven years. 

The general rule is that no tax deduction is allowed for expenses if they aren’t incurred “wholly and exclusively for the purpose of a trade”. That’s a reasonable and understandable restriction. However, there’s a unique angle to pre-trading expenses which can allow a deduction for costs that might originally not have been incurred with your business in mind. You might have spent money on an item long before you thought about starting a business, but if it was later used for your business and the expense was incurred within the seven-year time limit, the pre-trading rule allows you to claim a tax deduction for it. 

Example 

John was employed as a designer with a kitchen company. In early 2024 he decides to start his own furniture design firm which he’ll run from an office in his home. In late 2021 he bought new IT equipment and furniture for his home office, which he used almost entirely for private purposes. In mid-2023 he bought a stock of paper, ink cartridges and stationery for his private use. John can claim a tax deduction under the pre-trading expenses rule for the IT equipment and the paper, ink, etc.

 

How much can be claimed? 

Consumables bought pre-trading specifically for your business will be unused when trading starts and so the tax deduction is equal to the cost. However, if the item is durable (for tax purposes this means something that can be used multiple times for a period of two years or more) this is referred to as capital expenditure, e.g. equipment, it might be used or unused or have been bought for the business or for another purpose. The tax relief is allowed for: 

• the cost where the item was bought for the business and unused; or if used 

• the “market value”, i.e. the amount you could expect to receive if you sold it to someone unconnected to you, of the item if it was previously used for a purpose other than for your business. 

 

What about services? 

The same pre-trading rule applies to services as it does to goods. However, in practice it will only be relevant to purchases made specifically for your business. For example, if you take a lease on a retail unit with the intention of running your business from it, you’re unlikely to start trading there on the day you receive the keys; it might need fitting out or other work before you can use it. You might include the rent for this period, along with the fitting-out costs, in your business’s first accounts, but for tax purposes they are pre-trade expenses. 

 

Do I need to tell HMRC that I’m in business? 

Once you start trading you no longer have to consider the pre-trading tax rules; expenses and income from now on are subject to the general tax and accounting rules. You will need to step up your record keeping ensuring that accurate accounts can be produced for HMRC, other regulatory authorities, your bank and similar organisations, and of course you and your business partners (if applicable). 

Where you have a liability to income tax, whether it arises from business profits or other income, you must tell HMRC about it no later than 5 October following the end of the tax year for which you owe tax. The only exception to this is where HMRC has, before the October date, asked you to complete a tax return for the year in question, in which case there’s a deadline for completing and sending it to HMRC. If you miss the 5 October deadline there are penalties, usually ranging between 10% and 100% of the tax liability you didn’t tell HMRC about. 

You can register online at https://www.gov.uk/set-up-sole-trader.  

If you’ve already registered for self-assessment for another reason (for example, you have income from a pension or a property), you still need to register for self-assessment as a sole trader.  

Apart from HMRC issuing you with a tax reference number (unique taxpayer reference (UTR)), unless you had one already, you probably won’t hear from HMRC until it issues you with a notice to submit a tax return to declare all your income including your business profits.  

There is a slightly different process for registering a partnership. In this Special Report, we are only considering sole traders, but you can register a partnership at https://www.gov.uk/set-up-business-partnership/register-partnership-with-hmrc. 

 

How is my trading income taxed? 

If you make profits, these are subject to income tax and Class 4 NI. Class 2 NI is no longer payable on a compulsory basis - though it can be beneficial to pay it voluntarily in some cases where you have a gap in your NI record, and your profits don’t exceed the small profits threshold (£6,725 for 2024/25).  

As we are looking at secondary income sources, we will assume that there is also other earned income to consider in all the scenarios we cover. 

The first step in determining the tax liability is to work out the profits (or loss) for the business. The cash basis of accounting is now the default method to use. This allows you to work out your taxable profits based only on income you have received and expenses you have paid. This potentially simplifies record keeping: but you can still opt to use the accruals basis if you wish. 

Good record keeping is the key to maximising tax deductions and using the tax breaks available. If you aren’t comfortable or experienced in bookkeeping it will pay you to engage a specialist to do the work for you. However, they’ll need your input and help to ensure that money received, and costs incurred, by the business are allocated correctly. This will ensure correct tax bills and maximum tax efficiency. 

Paying too little might sound attractive, but if HMRC discovers errors you’ll have to pay the shortfall, plus interest and probably stiff penalties. 

The first step in determining the tax liability is to work out the profits (or loss) for the business. The cash basis of accounting is now the default method to use. This allows you to work out your taxable profits based only on income you have received and expenses you have paid. This potentially simplifies record keeping: but you can still opt to use the accruals basis if you wish. 

Good record keeping is the key to maximising tax deductions and using the tax breaks available. If you aren’t comfortable or experienced in bookkeeping it will pay you to engage a specialist to do the work for you. However, they’ll need your input and help to ensure that money received, and costs incurred, by the business are allocated correctly. This will ensure correct tax bills and maximum tax efficiency.

 

What can I deduct from income? 

General principles 

The general rule is that business costs are tax deductible where they are “wholly and exclusively” for the purpose of your business. A deduction for a proportion of expenses that are incurred partly for business and partly for other purposes is allowed where there is an identifiable part that meets the “wholly and exclusively” for business condition. For example, if part of the house is used wholly for business purposes for some of the time, a proportion of the household expenses are tax deductible. 

HMRC accepts that deductible costs can include an appropriate amount of fixed and variable household costs, where there is business use. It does, however, distinguish genuine homeworking from merely incidental or trivial business use, such as for writing up records once a week, which doesn’t alone permit a deduction for any household expenses. 

Even after you’ve established that an expense is tax deductible from your business income special rules may limit or modify the amount of tax relief you can claim. For example, where you choose to claim HMRC’s simplified expenses instead of the actual costs. See https://www.gov.uk/simpler-income-tax-simplified-expenses for details about simplified expenses. The ones that are most likely to be of interest are the approved mileage flat rates, and fixed deductions for working from home. If your expenses are going to be relatively low (less than £1,000 a year), you can take advantage of the trading allowance. 

The trading allowance works in two possible ways: 

1. It exempts from income tax up to £1,000 of business income. If your business income is no more than that there’s no need to claim the allowance or tell HMRC about your income as the allowance automatically applies. 

2. If your business income is more than £1,000 you can claim the trading allowance instead of business expenses you incur. Only business income received in excess of £1,000 will be taxable.

The trading allowance will be the most efficient option where there are limited expenses. You can choose to use it (or not) on an annual basis, so if your expenses are larger in a particular year, you’re not restricted. However, deducting the allowance can’t create or increase a loss. If you make a loss before taking the trading allowance is taken into account, you should elect to disapply it. 

Example 

Eric works for Acom Ltd as a manager. He starts to write articles for a trade journal which he is paid for on a freelance basis. Eric’s business costs are likely to be limited, so using the trading allowance fixed deduction might be sensible. However, suppose in year two, Eric pays £750 to attend a trade conference, £250 to a website designer, and ongoing web costs of £25 per month. These exceed the allowance, so it will be more beneficial to claim the actual costs.  

The flat rate for business travel in your own car is 45p for the first 10,000 miles and 25p thereafter. This might be useful if you travel to see customers or clients. This mirrors the position for employees. 

These rates apply to all cars, including electric vehicles, and there are separate rates for vans and motorcycles and so can be very valuable. Unfortunately, the approved employee rate of 20p for bicycles can’t be used for simplified expense claims for a trader. 

To use the flat rate you should keep a mileage log in case HMRC asks you to back up your claim with evidence. We have included a template spreadsheet for you. Note that if you use public transport, the cost will be deductible as long as it is incurred “wholly and exclusively” for the purposes of the business. 

Home-to-work travel doesn’t count as business travel and so it’s important to establish where your business is based. For example, you might be based at home, work from a separate business premises or have several bases. Generally, the cost of any travel you take from your work bases is deductible except where it’s to your home. 

Aside from these, for a small side trade, the types of expenses you might be able to deduct include: 

• the cost of maintaining a website (the cost of creation of a website is a capital expense) 

• the cost of a domain, e.g. for web hosting and email purposes 

• advertising costs or agent fees 

• some types of work-related training, e.g. for example for continuous professional development 

• a separate business phone line 

• consumables - printer paper, ink, branded stationery, etc. 

• business insurance 

• networking events and associated costs. 

Household expenses

If you don’t want to use the simplified expenses approach for the costs relating to working from home, you will need to make a reasonable apportionment between business and private use. How you do this will depend on your circumstances. Consider the following scenarios: 

Scenario 1. Owned property 

David uses the spare bedroom in his four-bedroom house as an office. He owns the property with the aid of a mortgage. David typically works 6.5 hours per day on weekdays for 48 weeks of the year. He uses the room for normal domestic purposes at other times. In addition to the four bedrooms, the house also has two reception rooms, a kitchen, a bathroom and two toilets. 

At its simplest level, the calculation that HMRC proposes suggests that we apportion relevant costs based on the proportion of use on a room basis. 

Kitchens, bathrooms, toilets, lobbies and hallways, being merely ancillary to the rest of the house, are generally ignored for these purposes, so we can effectively treat the building as a six-room house. So David’s total and business usage can be set out in the following terms: 

Total use = 6 rooms x 24 hours x 7 days x 52 weeks	52,416 room-hours
Business use = 1 room x 6½ hours x 5 days x 48 weeks	1,560 room-hours	2.97% (say 3%)

So we can take the business element of David’s household costs to be 3%; the principal costs are set out below. 

Note. In the case of loan repayments, it’s only the interest element that can be deducted and not the capital element. 

Mortgage loan interest (£600 per month)	£7,200
Council tax	£2,400
Insurance	£400
Electricity/gas	£2,400
Total	£12,400
Tax-deductible expenses (3%)	£372

 

Scenario 2. Rented property 

In this example, which is similar to the previous one except that the property is rented. Claire uses a room in her four-bedroom house as an office and works 6.5 hours per day on weekdays for 48 weeks of the year. The room is also used for domestic purposes when not used as an office. In addition to the four bedrooms, her rented house also has two reception rooms, a kitchen, a bathroom and two toilets. He deductible homeworking expenses are calculated as shown in the table below. 

Rent (£1,800 per month)	£21,600
Council tax	£2,400
Insurance	£400
Electricity/gas	£2,400
Total	£26,800
Tax deductible expenses (3%)	£804

Both examples are simple, and it may be that on a more precise allocation the amounts calculated might be smaller or greater. For example, the room used as an office might be especially large or small compared with others in the home and therefore an alternative apportionment of expenses should be considered. The calculation would be significantly different if the rooms used by David and Claire were not used for domestic as well as business purposes. 

 

Scenario 3. Rented property with exclusive use 

Rashid rents a four-bedroomed home which has three reception rooms (lounge, dining room and kitchen). He uses one of the bedrooms, which is more or less average in size with the other rooms, as his office. The room is not used for any other purpose. In all other respects the facts and figures are identical to those of Claire in Scenario 2. Rashid’s tax-deductible expenses are calculated as follows. 

Rent (£1,800 per month)	£21,600
Council tax	£2,400
Insurance	£400
Electricity/gas	£2,400
Total	£26,800
Tax deductible expenses 1/7th	£3,828

The same method of calculation would apply if Rashid owned or is purchasing the property, i.e. dividing the total costs by the number of rooms in the property (assuming that the room used for business is more or less average in size to the others in the property).

 

Water charges

There are also probably many other costs that aren’t included in the above examples; an obvious omission is water and sewerage charges. HMRC does say that where business use is minimal none of the water charges would be considered allowable. The only other situation it expressly mentions is where there’s a separately metered business supply which is fully allowable. 

In between the two situations there may be a basis for apportioning the expenditure. Unlike the other variable costs, there’s likely to be a higher non-business element: baths, showers, washing up, etc. So it may be more appropriate to include a more moderate proportion; although in David’s case if expenditure is moderate, we could probably apply the same 3%. 

Telephone and broadband 

Another obvious omission from the example is telephone and broadband charges. While HMRC likes to lump these in with other household costs, they not actually property-related expenses and the tax-deductible amount should be worked out separately from those relating directly to use of a property. Therefore, broadband and telephone usage can be apportioned between business and private use. 

Repairs and cleaning 

HMRC’s guidance also says that general repairs and cleaning can be apportioned like the fixed costs, but repairs and cleaning to specific parts of the property should be apportioned according to the use of that specific part. This seems entirely fair and reasonable. 

 

Can I choose the date to which I prepare my business accounts? 

Yes. However, it is recommended that accounts are drawn to 31 March or 5 April each year, unless there is a commercial reason to choose a different date. This is because from April 2024 the rules for allocating profits mean that the basis period for taxable profits for a tax year will be those arising in the tax year (6 April to 5 April). For example, if a business’s accounts end on 30 April, the profits for the tax year 2024/25 will be 1/12th of those shown by the accounts to 30 April 2024 or the month of April 2024 plus 11/12ths of the profit shown by the accounts to 30 April 2025. 

SECOND JOBS

How will PAYE apply to a second job? 

When you start a second job you should be asked to complete a new starter form. This helps HMRC to determine which is your “main” job, which is where your personal allowance will be allocated. When things go smoothly, your second job will usually be allocated a code or BR or D0, which deducts tax at 20% or 40%. 

If you are a Scottish taxpayer, you might receive a slightly different code. 

However, a number of problems can arise in a number of situations as the PAYE system doesn’t handle multiple employments particularly well. You could have problems if: 

• your starter checklist isn’t completed or not submitted, so you might have the personal allowance applied twice meaning you will underpay on the secondary income 

• your income from your main job doesn’t use the full personal allowance, so you might overpay on the secondary income; or 

• you change your main job, and HMRC is not informed in time to reallocate your allowances properly - you may have an emergency tax code allocated to your main job. 

A lot of people see an underpayment as a win. After all, it’s HMRC’s system that has caused the error. Unfortunately, the right amount of tax is always payable, the PAYE system doesn’t guarantee the correct amount will be deducted at source. An underpayment will usually be followed up by an assessment and a demand for payment if the issue doesn’t resolve itself in the tax year. 

 

How can I avoid problems?  

Firstly, ensure you complete a new starter form and choose Statement C which says you have another job. You should then receive a coding notice from HMRC telling you what the code for the new job is. This will usually be BR or D0, depending on the level of income you have from your main job. If it is anything else, you need to contact the number on the form, or go into your personal tax account, to find out why. 

If you have two part-time jobs, you might see HMRC split your personal allowance between the two of them. This will be done based on the estimate of your incomes from both in a way that should minimise any under or overpayment. This will then be reconciled after the year end, and you will receive a P800 setting out the position.  

It’s important to let HMRC know if the split is no longer appropriate, for example if you know you will be increasing your hours with one employer. 

 

My codes look fine - is that all I need to worry about? 

You also need to think about your NI. If you are of State Pension age, you shouldn’t be paying any employees’ NI at all. 

As we are considering second jobs, you won’t need to worry about NI if the secondary income is less than the primary threshold - £242 per week for 2024/25 as nothing will be deducted. The NI limits apply to each job in isolation, so you don’t have to pool income together like you do for income tax. 

Associated employments must be aggregated for NI purposes. This will be the case where the second job is for the same employer, or an associated company. 

An annual cap, known as the annual maximum, applies to a worker’s NI whether they have multiple employments within the tax year, or are both employed and self-employed (either successively or concurrently). Unlike income tax, the onus is very much on the worker to check whether they have overpaid NI and then to claim any refund due. Incredibly, HMRC has no mechanism to check the accuracy of NI payments nor any facility to provide an automatic NI refund. 

As the usual NI deductions made under PAYE only consider each employment in isolation for each earnings period, it is very possible that you will overpay Class 1 NI for the tax year overall. This is where the annual maximum needs to be calculated based on your particular circumstances, i.e. there is no overall universal figure. 

 

How do I work out my annual maximum and check for any overpayment? 

The eight-step process to determine your annual maximum is as follows: 

Step 1 

Deduct the relevant weekly primary threshold (PT) from the relevant upper earnings limit (UEL) and multiply that figure by 53. 

Here “relevant” means the PT and UEL in force during the year for which the maximum is being calculated. 

Step 2 

For tax year 2024/25 onwards, multiply the result of Step 1 by 8%. 

Step 3 

Add together so much of the person’s earnings from each employed earner’s employment as exceeded the PT but did not exceed the UEL. 

Step 4 

Deduct from the total found at Step 3 the amount found at Step 1. 

Step 5 

If the figure produced at Step 4 is a positive figure multiply that figure by 2%. If the figure produced by Step 4 is a negative figure, it is treated for the purposes of Step 8 as nil. 

Step 6 

Add together so much of the person’s earnings from each employed earner’s employment as exceeded the UEL. 

Step 7 

Multiply the result of Step 6 by 2%. 

Step 8 

Add together the results of Steps 2, 5 and 7. 

The result of Step 8 is the maximum amount of Class 1 or Class 1 (and Class 2 - though this won’t be relevant here) contributions that you can pay in respect of the tax year. 

In practice, you will only need to worry about this if your combined income exceeds the UEL in one or more pay periods.  

If you know in advance that you will earn in excess of £967 per week for the whole year, you can apply for deferment, which will restrict the amount deducted from your second employment to 2%. This should avoid the need to reclaim an underpayment.  

Deferment should be applied for as soon as possible to reduce the amount of any overpayment. Applications to defer contributions must be made in writing, using Form CA72A, ideally before the start of the tax year to which the deferment will apply (and certainly by 14 February within the tax year). At any time, the individual must notify HMRC of any change in circumstances which may mean that deferment is no longer applicable. 

If, after the end of the tax year: 

• insufficient contributions have been paid, an assessment will be made for any shortfall, which must be paid directly by the individual within 28 days of receiving such a demand; or 

• sufficient contributions have been paid, deferment will continue to apply for subsequent years, although a renewal form must normally be submitted. 

Form CA72A can be completed online, or printed out, at https://tinyurl.com/54x4w757.  

As you can only apply for a refund after the end of the tax year, you can currently only check for 2023/24 and earlier years. You need to be aware that 2023/24 involved a change of rate from 6 January 2024, so the process needs to be modified very slightly - changing the 12% used to 11.5% (the average rate for the year). Let’s take a look at HMRC’s published example to see how this works. 

Example - adapted from HMRC’s NI manual 

An employee has two separate employments. Their total earnings for the 2023/24 tax year are £100,000. They are paid monthly in each job and receive the same amount of earnings in each earnings period. Their maximum Class 1 liability is calculated as follows: 

Step 1 

Deduct the relevant primary threshold (PT) from the relevant UEL and multiply that figure by 53. 

£967 - £242 = £725 x 53 = £38,425 

Step 2 

Multiply the result of Step 1 by 11.5% (because the calculation is for the 2023/24 tax year) 

£38,425 x 11.5% = £4,418.88 

Step 3 

Add together so much of the person’s earnings from each employed earner’s employment as exceeded the PT but did not exceed the UEL at the time the payment of earnings was made. 

The earnings between the PT and the UEL for the first employment is £37,430. The same is the case for the second employment. The result of this step is therefore £74,860. 

Step 4 

Deduct from the total found at Step 3 the amount produced by Step 1. 

£74,860 - £38,425 = £36,435 

Step 5 

If the figure produced at Step 4 is a positive figure multiply that figure by 2%. 

If the figure produced at Step 4 is a negative figure, it is treated for the purposes of step 8 as nil. 

£36,435 x 2% = £728.70 

Step 6 

Add together so much of the person’s earnings from each employment as exceeded the UEL. 

The employee did not have any earnings above the UEL in each individual employment, so the result of this step is 0. 

Step 7 

Multiply the result of Step 6 by 2%. 

£0 x 2% = £0 

Step 8 

Add together the results of Steps 2, 5 and 7. 

£4,418.88 + £728.70 + £0 = £5,147.58 

The employee’s maximum liability for the 2023/24 tax year is £5,148. 

Having worked out the maximum, the amount of NI paid should be compared to it to determine whether a refund is due. We’re told that the earnings are the same from each employment, i.e. £50,000 each. Assuming NI was deducted correctly, NI paid will be 2 x £3,743 = £7,486, so there is a refund of £2,338 due.