If you operate as a sole trader, then you need to be knowledgeable about your tax requirements. This is why it is important to have a handle on your expenses to ensure that you are being taxed efficiently. At CloudCo, we will ensure that as a sole trader you pay the right amount of tax and advise you on what expenditures can be offset against your taxable profits.
A sole trader should claim allowable business expenses to avoid paying more tax than necessary. The phrase to remember in relation to expenses, is that you can only claim purchases “wholly and exclusively incurred in the performance of your duties”.
Allowable business expenses are also called “running costs” – these are expenses for purchases of whatever you need to keep your business running. These expenses do not include money taken from a business to buy personal items.
If you are a sole trader and want to know more about which expenses are considered tax deductible, then read our guide below.
How does a sole trader account for their expenses?
First, the trader must register as self-employed with HM Revenue and Customs (HMRC) and set up an online account. From this point on, a self-assessment tax return must be filed (and whatever is owed must be paid) every year by 31 January. A tax return then must be filed every year even if no profit has been made.
To be able to file an accurate tax return, records of business income and expenses (bookkeeping) are kept, to make it possible to work out what portion of gross income is subject to income tax and national insurance.
Taxable income is gross income less the personal allowance (£12,570 for 2021/22) and any other allowances and expenses. Once this has been worked out, then the tax return can be filed. Records must be kept for five years and they must be accurate and up to scrutiny.
While checking invoices against bank statements, tallying up expenses and working out other allowances all sounds simple enough. However it can get a lot more complicated depending on the size of the business and whether it pays people, buys plant or machinery, pays VAT, receives grants, etc.
Software such Xero is a really good tool to help sole traders keep up with bookkeeping, but for working out and submitting a tax return, hiring an accountant may well save a sole trader money in taxes and rescue them from making (potentially expensive) errors.
What records should a sole trader keep?
You should keep accurate up-to-scrutiny records of your expenses, invoices, bank statements, and any other paperwork that relates to running of your business.
These should be kept for five years, as HMRC could ask for the records and all related documents. Saying they are lost or have been shredded would not stand as a defence for missing business records. HMRC can and probably would charge a penalty if the records are not accurate, complete and readable.
Your records should include:
- All bank statements
- All sales and income – purchase orders, accounts received (invoices), etc
- All business expenses – receipts, accounts payable; money owed by the sole trader
- All VAT records (if VAT registered)
- All PAYE records (if employing people)
- Records relating to personal income (e.g. interest on shares, income liable for capital gains tax, lettings income from a property, that is, any money earned that is not taxed at source)
- Self-Employment Income Support Scheme (SEISS) payments if claimed
A record should also be kept up to the end of the tax year (5 April) of:
- What is owed but not yet received
- What money is committed but not yet spent (e.g. any invoices not yet due)
- Year-end bank balances
- How much money is taken out for personal use as “wages”
- Any investments
- Payments to charity
- Value of stock
- Value of work in progress
What expenses can a sole trader claim?
There are quite a lot of allowable business expenses to claim to avoid paying more tax than necessary. These include your “running costs” or business costs, that is, expenses for purchases of whatever you need to keep your business running.
Allowable business expenses do not include money taken from the business to buy personal items; remember business expenses are those “wholly and exclusively incurred in the performance of your duties”. That said, however, there are some exceptions for which you can apportion a percentage of the cost for business use, which will be mentioned below.
Expenses you can claim include:
- Office costs – e.g. stationery, letterhead, phone bills
- Travel costs – e.g. fuel (mileage), parking, train or bus fares
- Subsistence – if work takes you away from the office or home for the day or on overnight business trips
- Clothing expenses – e.g. uniforms
- Staff costs – e.g. salaries or subcontractor costs
- Things bought to sell on – e.g. stock or raw materials
- Financial costs – e.g. insurance, bank charges, an accountant
- Business premises costs – e.g. rent, heating, lighting, business rates
- Advertising/marketing – e.g. website hosting, design or redesign, print or online leaflet or brochure
- Training courses, but only if specifically related to your business – e.g. a refresher course
- Books and magazine subscriptions (only in relation to your business)
Note that allowable expenses cannot be claimed if using the £1,000 tax-free “trading allowance”.
Costs you can claim as capital allowances
Capital allowances can be claimed for something bought for the business and used over time, for example:
- Business vehicles, – e.g. a car, van, lorry
Note that capital allowances cannot be claimed if using the £1,000 tax-free “trading allowance”.
If something is bought for both business and personal use
Allowable expenses relate to business costs only: for example, a mobile phone bill for the year comes to £350. Of this, £200 relates to personal use £150 to business use. A business expense for mobile phone use of £150 can be claimed.
Tax relief can be claimed for:
- Gas and electricity
- Metered water
- Business phone calls
- A portion of the home office space
All of this must relate to the business in full, or if the use for business only forms part, then the correct percentage must be applied.
If working from home
A proportion of costs for the following can be claimed if working from home:
- Council tax
- Mortgage interest or rent
- Telephone use
A reasonable method of dividing costs could relate to the number of rooms used for business and/or the amount of time spent working from home.
Working out how much time is spent working could then be used to work out what portion of broadband, energy, water use belongs to the business, and so on. You can see why you might want to seek the services of a qualified accountant!
Complex calculations to work out sole trader business expenses can be avoided by using simplified expenses.
Simplified expenses are flat rates that can be used for:
- Working from home
- Living on your business premises
While the process of claiming allowable expenses appears simple, you should beware! There are some tricky parts to applying expenses correctly and advantageously, so if you’re unsure you should always check the HMRC website or contact a qualified bookkeeper or accountant.
How does a sole trader claim expenses?
To claim sole trader business expenses, the total amount of expenses is filled in on an annual tax return.
Before doing a tax return, it is a good idea to have been:
- Recording expenses as they occur: to make the job less of a hassle do it once a week.
- Keeping copies of all receipts and invoices: note down details relating to the expense being claimed for if the expense is associated with a specific project or client.
- Record-keeping: HMRC bench mark businesses to gain an overview of typical income and expenses in that field and they do pick out random businesses to investigate. If that unlucky tax payer cannot provide evidence of their income, purchases or these don’t match with other paperwork, a fine could follow.
Using cloud bookkeeping and accounting software like Xero, makes doing your bookkeeping a lot less arduous – done weekly, it’s a twenty-minute job, if that!
All expenses must be for the sole purpose of your business and HMRC can ask for proof, so definitely avoid claiming any personal items.
And another reminder, whether digital or physical, make sure copies of all expense receipts, invoices and bank statements and any other relevant paperwork is kept for five years. HMRC can run investigations retrospectively over the past five years.
What is a sole trader?
Sole trader is the term used for a type of enterprise owned and run by one person. It is the same as being self-employed.
The downside of this status is often stated as the lack of a legal distinction between the owner and the business entity (unlike a limited company), as this makes these individuals personally liable for any debt the business may incur.
Three upsides are stated too:
- The sole trader has absolute control over their business, its assets and profits after tax. The accounting process for sole trader is somewhat simpler than for a limited company (no need to file annual accounts or a corporation tax return), even though a sole trader must file a personal tax return annually to report trading profits and pay tax (less expenses and allowances).
- Accountants typically charge a sole trader less than a limited company to work out their tax and fill in a tax return ready for filing.
- More importantly, accountants often save sole traders (small businesses in general) a lot of money in tax. The services of an accountant are an allowable business expense.
Does a sole trader or limited company pay more tax?
It is less tax efficient to be a sole trader than it is to run a limited company, at least from the personal tax point of view.
This is because the former pay 20–45% income tax plus national insurance (on profit after the personal allowance £12,570 for 2021/22). The latter, however, pays 19% corporation tax on profits, as a limited company owner typically takes a small salary (below the tax and national insurance thresholds) and the remainder of their income in the form of dividends (which are free from national insurance).
Sole traders are taxed on the profits or losses of the sole trade personally, regardless of what profits they physically withdraw from their business bank account.
Can I use Xero expenses?
Yes, Xero expenses are suitable for self-employed people. With a bit of setting up and around six hours learning you’ll be good to go.
You can manage your finances and send invoices easily with accounting software designed for you. It costs around £12 a month and has many features that can help you run your business more efficiently.
However, even though the software is marketed as “accounting software”, doing you bookkeeping yourself is one thing, but doing your own accounts is quite another. An accountant (whose fees are an allowable expense) could save you more money than the fees you need to pay for their services.
Can I claim expenses working from home?
A self-employed sole trader should be claiming business expenses for working from home.
Ideally, you would designate one room in your dwelling as a home office and have a separate internet connection and phone line (mobile phone) for business to simplify things.
If you are a tenant of a rental property, legally you should check the tenancy agreement and/or check with your landlord that you are allowed to work from the premises.
If you share your personal phone, home space and internet connection then you should apportion the business use part. There are calculators to help you do this, or an accountant will gladly assist you in working it out.
A sole trader should claim business expenses to avoid paying more income tax than necessary. Allowable expenses relate to “running costs”, that is, expenses for purchases “wholly and exclusively” to keep the business running. Every single expense that relates to the business should be included to make the most of what allowable expenses can do to minimise tax.
Often, unless you are good with figures and somewhat aware of the law that relates to tax, the best way to make the most of business expenses is to hire an accountant.
At CloudCo, we know the ins and outs of all the expenses you can claim and the legislation that relates to them. When you employ an accountant who can explain how you can claim business expenses, there will be less mistakes made; it will save businesses time, and probably save you money too in the long run (as most of the time an accountant’s fees are less than what is saved by them for business owners/sole traders in taxes).
Using cloud bookkeeping and accounting software can also reduce errors and the time it takes to work out the expenses you can claim; using both Xero and a small business accountant, such as CloudCo, could increase your income and mean that your business runs more efficiently.