Posted on: 6th April 2018
The self-employed Day Trader
In this factsheet we outline the basic points to consider when HMRC deem your activities as a day trader to be that of an individual carrying on a self-employed activity.
Unless you decide to incorporate your day trading business and operate via a Limited company, then you will be a sole trader. Unlike operating a Limited company where the Limited company is a separate legal entity to the individual running the company; being a sole trader means that there is no distinction between the individual running the business and the business itself.
As a sole trader, the income and expenditure arising from the business is attributed directly to the sole trader. This means that the profits earned, net of expenses, are the sole trader’s own (after the payment of any taxes due). Subject to having paid the correct amount of tax, the sole trader can draw money arising from their self-employment earnings at their choosing. This is in contrast to operating a Limited company, where drawing money from the company will trigger a tax event. That is, that every time the owner of a company wanted to pay themselves from their Limited company, they would have to pay tax on that payment in one form or another. Please see our Limited company factsheet for further information.
As a new self-employed business, you will have to register for Self-Assessment and Class 2 National Insurance Contributions (NICs) as soon as possible after you know that your day trading activities will be that of a sole trader. In addition to paying Class 2 NICs, a sole trader also has a liabiity to Class 4 NICs. Where Class 2 NICs are a flat rate charge, Class 4 NICs are based on profits*.
You must register with HMRC when you are recently self-employed, even if you’ve submitted self-assessment tax returns previously. Please see the link to HMRC’s website which provides details and states the deadline that must be met for registering a self-employed business with HMRC:
*Please see the link to HMRC’s website showing the rates of Class 2 and Class 4 NICs:
Self-assessment tax returns
Before we discuss certain areas of tax planning that you should consider when starting in business as a sole trader, it’ll be helpful to provide a quick overview of the filing and payment deadlines for self-assessment tax returns.
The next deadline to keep in mind, for the submission of the 2017/18 self-assessment tax return, is 31 January 2019. This deadline must be met for those submitting online self-assessment tax returns for the tax year 6 April 2017 to 5 April 2018.
For the payment of outstanding tax, all tax due for the tax year must be paid by 31 January following the tax year. Therefore, for the 2017/18 tax year, all tax due must be paid by 31 January 2019. In addition to ensuring that the tax liability has been cleared for the previous tax year, the 31 January is also the day on which the first of two payments on account are made for the current tax year. The payments on account equate to 50% of the actual tax liability for the previous tax year.
The first payment on account for the tax year 2018/19 will be due on 31 January 2019 and the second payment on account by 31 July 2019. All tax due for 2018/19 must be paid by 31 January 2020. If the two payments on account made on 31 January and 31 July 2019 fall short of the total tax due for 2018/19, than a balancing payment must be paid by 31 January 2020 such that the tax liability for 2018/19 is paid in full by that date.
Don’t forget that a sole trader is also liable to Class 2 and Class 4 NICs, which is also paid through the self-assessment system.
A date’s a date! Isn’t it?
Now we came to a rather more confusing area of how a sole trader’s profits are taxed. You may think that tax advisers and accountants take the same view on everything. However, this is not the case. An accountant will prepare a business’s accounts based on certain principles, but there may be tax rules which, for example, require a particular expenditure in the business accounts to be treated differently for tax purposes. Similarly, it is not necessarily the case that the period of account, which is usually a 12 month period for which the sole trader’s accountant will draw up accounts, will coincide with the period that is to be taxed. This is a situation which usually occurs in the opening years of a sole trader’s business.
When starting in business as a sole trader, the sole trader can choose any date on which to close his/her books and draw up accounts. The date that the accounts are drawn up to is known as the accounting date. In the first year of business the accounting period may be longer or shorter than 12 months. After the first year, accounts are usually drawn up annually. However, for tax purposes, the tax charged in a tax year is based on the profits of the business earned in the basis period; and in the early years of trade, this doesn’t always coincide with the accounting period. The following example taken from HMRC’s Business Income Manual illustrates how this works in practice.
A business commences on 1 October 2012. The first accounts are made up for 12 months to 30 September 2013.
The basis periods for the first three tax years are:
2012/13 Year 1 1 October 2012 to 5 April 2013 2013/14 Year 2 12 months to 30 September 2013 2014/15 Year 3 12 months to 30 September 2014
As you know the tax year runs from 6 April to 5 April the following year. The business’s first accounts are made up to the 12 month period ending 30 September 2013 which falls between 6 April 2013 and 5 April 2014. Profits for the 12 month period will be taxed in the 2013/14 tax year. You will note that the profits shown in the first set of accounts are apportioned and taxed during the period 1 October 2012 to 5 April 2013 i.e. the 2012/13 tax year. Quite clearly a proportion of the first year’s profits (as shown in the first year’s accounts) have been taxed in both 2012/13 and in 2013/14. This is known as the overlap profit. It is possible to get overlap relief (a deduction of the amount taxed twice) in the tax year that the business ceases to trade and/or an earlier year, where there is a change of accounting date and where the basis period for that tax year is longer than 12 months. Where the sole trader draws up accounts to 5 April each year, starting from the commencement of trade and throughout the life of the business, there will be no overlap periods. In the example above, you can see that from the tax year 2014/15 everything falls into line.
As you can see there are a few things to consider when you start a business as a sole trader. The likelihood is that your self-employed day trading activities may already be under way and the date on which you began your day trading business was somewhat arbitrary. It is possible to change your accounting date once you’ve started in business but there are certain conditions that must be met for HMRC to recognise the change.
Why not simply prepare accounts up to 5 April every year and avoid overlap profits? It does sound as though this would make things easier, however, there’s another factor to consider. What should also be considered is when tax has to be paid on the profits shown in the accounts for a particular accounting period.
The following example illustrates how an accounting date that is early on in the tax year could have its advantages in terms of the delay between the earning of profits and the payment of tax on those profits.
Mr A has been a self-employed day trader for a few years and his latest accounts are made up to the year ending 30 April 2017. He will need to account for these profits in the 2017/18 tax return and pay the balance of any tax due on 31 January 2019, that is 21 months after the profits have been earned.
Drawing up accounts for an earlier date in the tax year will give you more time get your accounts and tax computations prepared to meet the filing deadline. An accounting date earlier in the tax year means that the profits for the year to 30 April can be calculated before the second payment on account is due on 31 July. Preparing the accounts promptly after the 30 April year end would enable a more accurate 31 July payment on account.
It should be noted, however, that having an earlier accounting period will give rise to a longer overlap period in the early years of the business. In addition, it can be confusing to have profits assessed by HMRC in the year after they are earned. Where profits are rising, giving rise to an increasing tax liability, some might consider it advantageous to defer the payment of tax until the year after the profits are earned. However, if profits are falling, then tax and NICs will have to be paid out of reducing income. Either way and particularly if profits are falling, it is wise to make provisions for future tax payments and put aside enough money to pay any forthcoming tax and NIC liabilities.
Having an accounting date other than 5 April can be of benefit, however, there are things to consider. When instructing an accountant to prepare your first set of accounts you can seek advice as to the most suitable date to which you should draw up your accounts, given your specific requirements.