Tax self-assessment is the method used by HM Revenue & Customs (HMRC) to collect income tax and some types of National Insurance Contributions (NICs) annually through a tax return. Anyone who has sources of income that have not been taxed under PAYE (Pay As You Earn) must complete a self-assessment return and submit it to HMRC. This normally relates to sole traders or partners who are running a business on a self-employed basis. However, some individuals with investment or rental income, and company directors must also account to HMRC under self-assessment by declaring their personal income.
What is the tax self-assessment process?
In order for income tax to be collected under self-assessment, anyone who is required to declare their un-taxed income must register for self-assessment with HMRC, complete an annual tax return and pay any tax due in two instalments each year. Partnerships have to submit a partnership tax return in addition to individual returns on behalf of each of the partners.
HMRC sends a letter each April to everyone who is registered for self-assessment, reminding them to complete their tax return, which must be submitted, at the latest, by the following 31 January, although filing deadlines vary according to the method of submission.
Who must register with HMRC for self-assessment, and when and how must they register?
All sole traders and partnerships must contact HMRC (www.gov.uk/government/organisations/hm-revenue-customs) to register for self-assessment when starting up. Failing to register can result in a penalty of £100 and further penalties for trading illegally and not paying tax.
As best practice, sole traders must register for tax self-assessment with HMRC as soon as possible after starting to trade, and at the latest by 5 October after the end of the tax year for which a tax return is needed. For example, anyone starting to trade between April 2017 and March 2018 must register by 5 October 2018.
The registration process takes at least 10 working days to complete as it involves HMRC posting out a 12-digit activation code, which is required when logging on to the online account.
Anyone registering for self-assessment is also issued with a 10-digit Unique Taxpayer Reference (UTR) and a user ID (also known as a Government Gateway Account), and can then create a password and report details of any earnings from self employment or income as a company director by completing an online tax return each year.
When setting up a partnership, although the process for registration and deadlines are essentially the same as for sole traders, one person must be designated the 'nominated partner' who is responsible for keeping the business records and managing the partnership's tax returns. Each individual partner must be registered with HMRC for self-assessment, and the partnership must also be separately registered. However, nominated partners who register the partnership for self-assessment will also automatically be registering themselves.
Partners do not have to be individuals, as a private limited company is treated in law as a 'legal person' and can also be a partner, so must also be registered for tax self-assessment, as must Limited Liability Partnerships (LLPs).
It is mandatory for a company director to file a tax return if one has been issued to them by HMRC. However if a self-assessment return has not been issued by HMRC and a company director has no further tax liability when sufficient tax has been deducted at source to meet their liability for the tax year, there is no requirement for the director to file a self-assessment return for the year in question.
Sole traders and traditional partnerships can register for self-assessment online at www.gov.uk/new-business-register-for-tax.
Company directors can register online by completing form SA1 (https://online.hmrc.gov.uk/shortforms/form/SA1).
Partners that are not individuals cannot be registered online and in this case form SA402 must be completed and posted to HMRC (www.gov.uk/government/publications/self-assessment-register-a-partner-for-self-assessment-if-theyre-not-an-individual-sa402).
Limited Liability Partnerships (LLPs) cannot register online either, and in order to register an LLP for self-assessment, form SA400 must be completed and returned by post to HMRC (www.gov.uk/government/publications/self-assessment-register-a-partnership-for-self-assessment-sa400).
The 'tax year'
Self-employed people trading as sole traders or partnerships pay income tax on their profits rather than on their gross income, and the profits on which tax is due (taxable profits) are calculated after deduction of the allowable expenses of running a business. They also have to pay Class 4 NICs, which are calculated as a percentage of profits and paid with any tax due.
The information included in a tax return, which is used to calculate any tax due, relates to the income received and expenses incurred that result in taxable profits in a given 'tax year'. The tax year runs from 6 April in one calendar year to 5 April in the following year, for example 6 April 2017 to 5 April 2018.
Tax year dates do not always coincide with the business' accounting year end, which is the annual period over which profit and loss accounts and other financial statements are prepared. However, in order to simplify accounting processes and the completion of tax returns for most start ups, if possible the business' accounting year should also end on 5 April.
In the first year of trading, sole traders and partnerships can prepare their trading accounts over a shorter period than 12 months, in order that the accounting year-end can be brought in line with the tax year-end. For example a sole trader who starts to trade at the beginning of October could choose to end their accounting year on 5 April the following year, so that their first year's trading accounts would show figures for only six, rather than 12 months.
Record keeping requirements for tax purposes by sole traders and partnerships
Following registration for self-assessment, sole traders and partnerships must keep full and accurate records of all business sales and expenses as well as details of personal investment income so that a tax return can be completed in due course.
Hints and tips
- It is important to register for tax self-assessment as soon as possible and to allow plenty of time as the registration process takes at least 10 working days to complete.
- All paperwork related to the tax year, such as subcontractor vouchers and bank and building society interest certificates, should be kept together to make completing the return quicker and more efficient.
- Details of user IDs and UTRs should be kept in a safe place that can be accessed easily, as they will be needed each time when logging on to the HMRC website.
- Self-assessment can be made easier by getting accounts prepared as soon as possible after the year end.
- Digital tax accounts will be introduced during the next Parliament, according to the Chancellor 2015 budget, and will reform the way individuals complete annual tax returns. Further details of the changes will be published by the Government later in 2015.