The profits of a self-employed person are charged to income tax by the income tax ( Trading and Other Income ) Act 2005. A self-employed person may be conducting a trade or may be exercising a profession or vocation. However, the profits of trades, professions and vocations are all taxed in accordance with the same set of rules.

Badges Of Trade

Income Tax Trading and Other Income Act 2005 or known as ITTOIA 2005 states that the trading profits of a person who is resident in the UK are chargeable to income tax whatever the trade is carried on. The trading profits of a non-UK resident are chargeable to income tax only if the trade is carried on wholly or partly in the UK. When deciding whether a person is trading it is necessary to make two important distinctions:

  • The distinction between employment and self-employment.
  • For an individual tax payer who sells goods or other assets, the distinction between trading activities (which give rise to trading profits) and non-trading activities (which will usually fall within the scope of capital gains tax).

Self-employed people enjoy considerable tax advantages when compared with employees

Two of the main advantages of being self-employed are:

  • A much wider range of expenses is allowed against the income of self-employed people than against the income of employees.
  • Self-employed people pay their income tax by instalments and effectively pay their tax much later than employees, who would normally pay their tax immediately under the Pay As You Earn System.

It is usually obvious whether someone is employed or self-employed but sometimes there are borderline cases. For Example, it may be extremely difficult to distinguish between and employee with several part-time jobs and a self-employed person with a few clients. In such cases, the taxpayer will usually wish to claim self-employed status, whilst HMRC will often insist that the taxpayer should be treated as an employee.

The key test to be applied when trying to establish a taxpayers’ status in cases like these is concerned with the nature of the contract between the taxpayer and the person who is actually paying for the work done by that taxpayer. There are in law: Two possibilities:

  • A. If it can be shown that a contract of service exists then the taxpayer is regarded as an employee who is in service to an employer and therefore should be classed as an employee.
  • B. If it can be shown that a contract for services then the taxpayer is regarded as a self-employed person who is rendering his or her services to a client.

The main criteria’s in determining whether you are employed or self-employed and certainly how
HMRC would make its decision are as follows:

  • Control.  The more control that the person who is paying for the work has over the person who is doing the work, the more likely it is that a contract of service exists. Employees are usually liable to choose whether or not to do certain work, how to do the work, when to do the work or where to do the work. Self-employed people are usually able to decide these matters for themselves.
  • Remuneration and financial risk. Employees usually receive a regular wage or salary: they are paid if their employer is making a profit or not and do not risk their own capital in the business. Self-employed people are normally paid a separate fee for each job they do: they make losses as well as profits and may lose their capital if their business fails.
  • Equipment. In general, employees do not provide their own equipment but self-employed people do.
  • Work Performance and Correct: Employees are usually expected to do their work themselves. If they make mistakes they will correct the work during working hours and get paid for both the original work and the corrections. Self-Employed people are normally paid a separate fee for each job they do: they make losses as well as profits and may lose their capital if their business fails.
  • Holidays and Sickness: Employees are likely to receive holiday pay and sick pay from their employers. Self-employed people are paid by their clients only for the work that they do and do not get paid when on holiday or when ill.
  • Exclusivity: In general, an employee is employed by just one employer and is an integral part of that employer’s business. Self-Employed people normally have several clients and are not integral to any of their clients’ businesses.

It is always best to judge each case individually.

HMRC may make state that a self-employed person has been treated incorrectly and should have been classified as an employee. They may demand that “the employer” pays employer national insurance contributions and backdate the payments to the original date of employment! In addition, they may add fines and interest.

If you have any questions in relation to whether you or any subcontractors should be classified as employers please contact us at Manchester Chartered Accountants for a free consultation without obligation.

Cash Basis and Simplified Expenses

As from tax year 2013-2014, small unincorporated businesses may choose to calculate their profits for tax purposes on the cash basis. If this basis is applied, taxable profits are simply the difference between income actually received in the accounting period and expenses actually paid out in cash.
There is no need to adjust for debtors, creditors or stocks. Nor is there any need to distinguish between capital expenditure and revenue expenditure. The main features of the cash benefit are as follows:

For this purpose, a small business is one which has total receipts in the accounting year that do not exceed the VAT threshold as it stands at the end of the tax year concerned ( ie: the tax year in which the profits for that accounting year are taxed). The Vat threshold is currently £83,000 (1st December 2016).

  • Use of the cash basis is entirely optional. In general, eligible businesses may start or stop using the cash basis whenever they wish. Once a small business starts using the cash basis it may continue to do so in subsequent years even if its receipts exceed the Vat threshold in those future years. However, businesses must stop using the cash basis when their receipts exceed twice the Vat Threshold) currently £186,000 as at 1st December 2016).
  • Receipts are defined as all amounts received in connection with the business during the accounting period, including disposal proceeds of non-current assets.
  • Expenses are defined as any payments made during the accounting period wholly and exclusively for business purposes, including capital expenditure. However, there are special rules relating to certain types of expenses. In particular:
  • Expenditure on buying a motor car is NOT deductible as an expense. Businesses may choose to claim fixed rate deductions in relation to their motor expenses and these include an element of depreciation. But if the fixed rate deductions are not claimed, the business may claim capital allowances in relation to the purchase of a motor car.
  • No deduction is allowed for capital expenditure which does not qualify as plant and machinery ( eg. The cost of acquiring land and buildings).
  • Loan interest is allowable up to a maximum of £500.00
  • In the case of vat registered business receipts and expenses may be recorded either including or excluding VAT. If VAT is included, then any VAT refunds received from HMRC are treated as receipts and VAT payments made to HMRC are treated as expenses.
  • Businesses which choose to adopt the cash basis are prohibited from claiming capital allowances except in relation to motor cars.
  • If a business which is using the cash basis incurs a trading loss, that loss can only be carried forward and set against any profits arising from the same trade in subsequent years. “Sideways relief” is not available.


Any unincorporated business may choose to use the “fixed rate deduction scheme” when calculating certain expenses for tax purposes. This scheme is available whether or not the business is small and whether or not it has adopted the cash basis. But the scheme is not mandatory and businesses may choose to claim the actual expense incurred if they so wish. The expenses concerned are as follows:

  • Motor Expenses: Motor Expenses in relation to a car, goods, vehicle or motor expenses may be calculated with reference to specified mileage rates. At present, these are the same as the employee AMAP rates. If a fixed rate deduction is made in relation to a vehicle, no other expenses or capital allowances may be claimed in relation to the vehicle and use of the fixed rate deduction scheme is then compulsory for that vehicle in all future periods.
  • Use of Home for Business Purposes. A self employed person who uses his or her home for business purposes may claim a standard deductions based upon the number of hours spent working at home. These vary from £10/month to £26.00/month and cover light, heat, power, telephone and broadband and internet costs.
  • Business Premises used partly as a home : If business premises are used partly as a home, the private proportion of expenses incurred in relation to the premises may be calculated as a fixed amount based upon the number of occupants. For instance, if there are two occupants, the private element is a standard £500.00 per month.

If there are any issues you may have in relation to cash basis and simplified expenses please contact us at Manchester Chartered Accountants for a free consultation on Tel; 0161-278-2714

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