VAT returns. Income tax returns. Anything to do with accounts makes me want to yawn. However it’s important that we freelancers ensure we operate as tax efficiently as possible. If you’re new to freelancing, one of the first things you should do is hire a good accountant or book keeper who can advise you on how to go about this.
As I’m neither an accountant nor a book keeper, I’m not qualified to advise on this subject. But luckily I came across this article in Money Observer last week that gives an excellent overview of the things you should consider in order to be tax efficient. Please note that this information applies to the UK only.
“As a freelancer or contractor your income is everything. You can’t rely on a steady salary or bonuses to keep you afloat. How you run your business has a direct, immediate effect on your bottom line – so it’s important to make sure you’re as tax-efficient as possible.
Generally the first thing to consider would be the structure of the business itself. For freelancers there are two options – a limited company or a sole trade. Which approach is more tax-efficient depends on the profits you are generating and how those profits are extracted from the business.
As a sole trader, you will pay income tax and National Insurance contributions (NICs) on your profits – whether or not you extract the profits from the business. Comparatively as a limited company you will only pay corporation tax on your profits, and income tax and NICs on any salary can be minimised by extracting dividends instead, and leaving your profits in the company – perhaps with a view to using them for expansion. Assets that are transferred into your company may also be claimed and the value owed to you paid back without tax.
One important way of ensuring maximum tax efficiency is to claim all expenses to which you are entitled. These expenses reduce your overall profits and therefore reduce the amount of tax you will pay on those profits. Expenses include things like travel to and from clients’ sites, subsistence expenses such as lunch and overnight accommodation, and mileage allowance for the use of your car. Allowances are also given for equipment your business may purchase such as a laptop or tools, and may also be claimed on those assets that were owned prior to the date you started your business.
Many self-employed individuals do not realise they can also offset the costs of working from home against their profits. Utility bills and rent/mortgage payments can be correctly apportioned and offset against profits to reduce your overall tax bill. The interest paid on a loan to start your business or inject funds into your company may also be claimed.
VAT may also be embraced if your customer base is VAT-registered and thus the addition of VAT would not make you more expensive. Indeed, it can be beneficial to operate under the flat rate scheme, whereby you pay a flat rate on your gross sales, the level of which is dependent on your business sector. This simplifies your bookkeeping as there is no need to separate out the VAT on your purchases. You can also claim back VAT on pre-registration expenses: claiming back six months for services and up to three years for VAT on assets. Your first VAT return may therefore be much less than anticipated.
With higher rates of income tax it can be beneficial to grow your business then sell in order to create a capital gain. This can be taxed at a much lower rate, particularly if you are entitled to Entrepreneurs Relief.
You could engage family members in your business. Payment of legitimate wages can make use of their personal allowance and obtain a tax deduction for your business. Spouses can potentially be partners or shareholders to utilise their basic-rate tax band and thus reduce a potential higher rate liability.
Pension contributions made by you or your company could be directed into a self-invested pension plan (Sipp) to finance the acquisition of commercial premises. The property would then grow tax free within the plan and rent paid to occupy the property would be tax deductible for your business yet be a tax free income of your pension. This effectively gives you tax relief on the capital purchase.
You should, however, take great care to claim only legitimate business expenses and keep accurate records as well as submit your tax returns in good time. There is a draconian penalty regime operated by HMRC for lateness and for inaccuracies. So whilst there are many ways to achieve tax savings you should be mindful that your record keeping is now, more than ever, subject to close scrutiny should you be unlucky to be selected for review.“