The adage that the only two certainties in life are death and taxes may be a little close to the bone for anyone who’s spent January shouting at an HMRC webpage whilst trying to unravel the dark arts of the self-assessment tax return.
As we breathe a collective sigh of relief that all those tax returns are, well, returned for another year, we thought we’d take the opportunity to set you up with a short glossary of accountancy and tax terminology that may – or may not – have been at the root of those outbursts a few months ago.
Capital Allowances
Every business needs stuff to function. Whether you’re car-based and need a vehicle to operate your business or rely on a laptop, capital allowances allow you to deduct the cost of capital assets before you pay tax on income. There’s a list of what you can and can’t claim for and naturally, there’s a limit as well. For 2016-17 the AIA (Annual Investment Allowance) is £200,000 for business related capital assets.
Cash Basis
This is an alternative way to work out income and expenses for your tax return if you’re a sole trader or partner (and have an income of less than £83,000). It’s supposed to be a simpler model of working out your accounts, as you are only ever recording money you’ve received in a tax year, not including monies owed. What this means in practice is that if you invoice someone on March 15, 2016, but only receive the money on April 21, 2016, it would be recorded on your 2016/17 tax return, not your 2015/16 one (as you would in traditional accountancy).
HMRC
Her Majesty’s Revenue & Customs. Think James Bond, but with less espionage, more paperwork.
Income Tax
All income is subject to taxation, whether it’s from employment, profit you’ve made from business, gains from pension income or savings accounts. We could include a joke here about taxation for offshore investments, but we’re not going to. We’re classier than that and we know you are too.
NICs
National Insurance Contributions. Tax by another name, really, though you pay National Insurance to qualify for a state pension, so it’s probably a good idea to keep these up. It’s worth remembering that NI isn’t a catch-all term: there are Employer and Employee NICs. As a freelancer, it’s as well to know the difference.
Class 1 contributions are paid by your employer, so if you can cast your mind back to those days before you were self-employed, you might remember those deductions on your payslip. If you can’t remember, trust us. They were there.
In the world of the self-employed, it’s slightly different and just like income tax, it’s your responsibility to pay these contributions. As to how much you’ll pay, this comes down to what your business profits are. Chances are you’ll have to pay Class 2 and/ or Class 4 contributions, which are:
| Class 2 (if your profits are over £5,965 per year) | £2.80 a week |
| Class 4 (if your profits are over £8,060 per year) | 9% on profits between £8,060 and £43,000 2% on profits over £43,000 |
PAYE
Pay as You Earn. This is the way you commonly pay your taxes, that is, as you go. These are usually reconciled quarterly in the freelancing world.
SATR
Self-Assessment Tax Return. Every freelancer’s favourite part of January is completing these lovely forms. Of course, getting an accountant to help lessens the load more than a little, but whether you’re wading through the form on your own or working with someone else, it’ll have to be submitted online before January 31 or the bears will get you. And, by bears, we mean HMRC. Remember them?
Self-Assessment
If you’re a freelancer you’ll have to take responsibility for your tax affairs and ensuring you pay however much tax is due. If that sounds daunting, it needn’t be. Accountancy may seem like a dark art, but there are myriad tools about these days to help even the most terrified.
Simplified Expenses
If you’re a sole trader or a company that doesn’t have a partnership with a limited company, you can use simplified expenses to calculate expenses. It’s pretty simple, really. When it comes to filling out your tax return, instead of working out exact amounts from your receipts you can opt to use a HMRC-generated flat rate.
All other expenses have to be filled out separately, but this may be a useful option if you’re a smaller business, juggling home life with work. Bear in mind that this can only be used on three things: 1) business costs for vehicles, 2) working from home and 3) living in your business premises.
Sole Traders vs Limited Company
In a nutshell: if you’re a Sole Trader, you are your company and any liabilities will fall to you personally. If you’re a limited company, you keep things separate. Here’s little thing we penned earlier to clear things up. You can find out more about the differences here.
Tax Bands
Everyone is entitled to the first £11,000 of their income to be tax free (as of April 2016, and this will rise to £11,500 from April 2017).
The bands are now thankfully much easier to understand than they were years ago:
| 20% | BASIC RATE | 0 – £32,000 |
| 40% | HIGHER RATE | £32,000 – £150,000 |
| 45% | ADDITIONAL RATE | £150,000 + |
Let’s see how this works in practice, then.
Here’s James McMoney. He’s had a pretty good year. His income was £53,000. Nice one, Jimmy.
Now, where lots of people go wrong is in assuming that because his income is above the threshold for basic rate tax, he’ll be taxed at 40% for his entire income. That’s not quite right. It wouldn’t be, would it?
Let’s work from the bottom up.
He pays tax at the basic rate for income up to £32,000, but like everyone else, gets his tax-free allowance of £11,000.
£53,000 – £11,000 (tax free allowance) = £42,000 with £32,000 liable for tax @ basic rate (20%) = £6,400
He then pays higher rate tax for the remaining income over £32,000.
£53,000 – £43,000 = £10,000 liable for tax @ higher rate tax (40%) = £4,000
So Jimmy’s income tax bill would be £10,400 (but this is before we get to any other deductions or exceptions, so think of it as a rough guide and nothing more).
Tax Relief
HMRC throwing us self-employed folks a bone. Tax relief is the system whereby some of your business expenses are deducted before you calculate your tax bill, thereby lowering it. Thanks, HMRC!
The Financial Year
So let’s get a little nit-picky. In the UK, The Financial Year runs from April 1 to March 31 the following year. These are relevant for corporation tax and government financial statements. The Fiscal Year, by contrast are the dates to pay attention to if you’re self-employed or pay personal tax. This runs from April 6 and ends April 5, the following year.
UTR
Unique Taxpayer Reference – this will be on documents that you receive from HMRC, and you’ll get it when you first register for tax. It’s probably a good idea to put it somewhere safe and not use it as a bookmark or coaster.
VAT
Value Added Tax. This is currently paid at 20% as a flat rate, but because the world of taxation is inherently never as simple as it should be, there are of course exceptions. There’s an exhaustive list of what goods and services are exempt here, and we’ll quiz you on that later.
