By Marcin Durlak on Small Business UK - Advice and Ideas for UK Small Businesses and SMEs
Buried in the small print of last October’s Budget was a change in the rules as to how tax is calculated for the self-employed.
More than 500,000 sole traders – i.e. the self-employed or unincorporated businesses – now face an average extra tax bill of around £3,000 a year in a move which will net the Treasury £1.7bn over the next five years.
It’s no wonder this has already been criticised for putting an extra burden on the self-employed who have already had a tough time throughout the pandemic.
What’s changing in how the self-employed report tax
From 2024, all unincorporated businesses will need to make sure their profit and loss reporting is in line with the tax year, as accounting dates can run at any time of year under the current system. HMRC has said that any additional tax can be spread over a period of five years to ease the cash flow.
The Government has said this simplification will make the system more accessible for the self-employed. Currently, because it’s so complex, sole traders have been unable to claim the tax reliefs they are also entitled to, runs the argument. So the idea is the increased tax bill won’t be as keenly felt due to the reliefs the self-employed will now be able to access.
However the Institute of Chartered Accounts in England and Wales (ICAEW) has contested that this new system could create uncertainty for sole traders because “such businesses are now likely to face increased costs and uncertainty due to the need to use estimated figures in their tax returns”.
The accountancy body concluded that “on further consideration we do not see it will provide any substantive simplification benefits to the UK tax system”.
>See also: Should you register as a sole trader or a limited company?
Should sole traders set up limited companies?
Becoming a limited company can have many benefits including:
- Lowering your tax bill
- Relieving you of personal liability of your business
- Legitimising, protecting and enhancing perceptions of your brand
- Scope for different shareholders/directors
For those who have higher profits the above can be a very sensible and smart move.
If your business was to incorporate, this would result in a cessation of the self-employment or partnership, which in turn prompts a specific calculation which can result in a longer period being assessed. However, you could benefit from historic “overlap profits”. In this case, ceasing your self-employment could potentially result in a lower tax bill.
However it’s not always suitable for those with lower profits, even if it could help you swerve the increased tax. It can be a relatively big cost in money and time to become a limited company, and if you’re not earning much or don’t plan to in the future, it could cost you more than the extra £3,000 you may have to pay per year.
It’s worth reviewing what your future plans are with your business. Becoming incorporated doesn’t always favour a business if your profits aren’t high enough. And remember it will create extra paperwork for you that might squeeze your time further.
There are pros and cons to incorporation v self-employment, and the process can take several months. Each tax situation needs to be looked at carefully, and advice taken from a professional. In the meantime, businesses should start to plan for the possible impact on cash flow ahead.
Marcin Durlak is managing partner at IMD Solicitors
Further reading
Registering your business: sole trader or limited company?
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Marcin Durlak, Khareem Sudlow
