Tax rules and regulations for the self employed are continually evolving and it can be hard to determine what rules apply to you. So whether you are a seasoned freelancer or new to the game, it is worth getting advice from the experts. Tim Cook, Tax Partner at Wilder Coe LLP and ex-HMRC , recently discussed the tax implications of working as a freelance lawyer at a Wednesday Live workshop for Obelisk Support legal consultants. From the type of legal entity used to transferring your business or working out your VAT situation, he covered the whole range of freelance working tax-related topics in the UK and showed that each step of this complex tax picture requires careful consideration.
Note: This article does not constitute legal advice and as with any fast-moving legal field, you should always consult HMRC or professional advisors for your own tax situation.
1. Registering with HMRC as a Freelance Lawyer
First things first. At Obelisk Support, we constantly onboard lawyers who are new to the life of legal consultants. If you are new to working as a freelance lawyer, you do need to register as working for yourself with the HMRC. There are various ways to do this.
• Self-employed. Register with HMRC for income tax. As a sole trader put 30% – 46% aside for tax purposes. Taxed on earnings when you earn them
• Traditional Partnership. Register with HMRC for income tax
• Limited Liability Partnership (LLP). Register with HMRC for income tax
• Limited Company. Once you’ve registered the company with Companies House, you have to register for corporation tax.
There are liability reasons why having a company is more relevant than any other status, together with potential client requirement for employment purposes – ‘off payroll’ engagement. Note that if you work for the public sector via an intermediary, the HMRC will be operating PAYE as of April 2018 (Off Payroll Working) and it’s possible that the private sector will have the same obligation in the near future.
If you are doing your taxes yourself, you will have to log into Government Gateway to file your taxes and will be taxed at later stage.
Taking Money Out of a Company
You can take money out of your company, either as a dividend or as salary, which will trigger income tax liability. At company level, the company will need to pay corporation tax on profits. To avoid paying twice and from a tax liability perspective, consider leaving the money in the company and ultimately liquidate the company, then pay entrepreneurs tax at 10%.
VAT registration will depend on your sales, but you need to bear in mind that the definition of sales may include more than your fees.
In theory, you need to register once your sales exceed the current £85,000 threshold in any one 12-month period. However, it is a tax on VAT taxable turnover, not on profit or fee income. At end of each month, you need to determine the sales in that month and add to sales in previous 11 months – add them together and if they are over £85,000, you need to register for VAT. You are supposed to check this every month and if you exceed this sum, you have 30 days to register. Failure do register will result in a fine.
On April 1, 2019, VAT-registered traders will need to use a digital filing system that electronically submits data quarterly to HMRC. It will affect everyone, whether or not you are on a VAT flat rate scheme. You won’t be able to use spreadsheets, but you may be able to use a software to send your calculations to HMRC. Since the HMRC will not provide free software, you will need to find commercial software on the market but whether or not it meets the HMRC requirements will depend on each software.
Note for Expenses
If you incur the expense and are then reimbursed, you must charge VAT on the invoice. Your income for VAT calculation is turnover – thus your fee and any charges. An example. Invoice says Fee = £1000 and travel = £500, the total is £1500 plus VAT. You will charge 20% VAT on £1,500 (you are owed £300 VAT) and so your invoice should charge £1,800 (including VAT). If you don’t, you will be penalised. If the travel expenses are paid directly by the client, you don’t have to charge VAT. In all cases, you should always get receipts showing VAT separately. If you want to charge a client for anything then get a receipt showing VAT separately. It has to show a trading name, address and VAT number.
Also referred to as Real Time Information (RTI), PAYE is a scheme run by HMRC to collect National Insurance Contributions (NICs) and Income Tax for all employees of a limited company, including the directors. Directors are classed as employees and pay National Insurance on annual income from salary and bonuses over £8,164. To pay yourself and any other employees a salary, bonuses or expenses, you will need to be registered. If you have employees (sole trader, partnership or LLP) or people under your control, again you need to be registered to RTI via the Government Gateway for payment of salaries.
Note on your Risk Profile
HMRC operates a ‘credit score’ which is akin to a risk profile whereby they monitor activity relating to late registrations, payment, amendments and errors. If you have a poor risk profile, this will make you more liable to receive tax enquiries from HMRC. Be aware of diary recordings this can be classed as a business record and made the subject of disclosure.
HMRC is increasingly strict and clamps down on what can be claimed as expenses. They are particularly observant of claims for home and commuting expenses.
- Commuting. If you work at a particular address on a regular basis, it becomes a workplace. Traveling from your home to that regular workplace is considered commuting. Commuting expenses are not tax deductible.However if you travel to a non-regular meeting that doesn’t follow a regular pattern, this may be an expense. The key is to maintain your records.
- Use of home as office. Using your home as an office and claiming expenses in relation to this is under close scrutiny. You can calculate your actual position by using fractions but do not state exclusive use of a room as an office 24/7 if you own your home, as this could have an impact on capital gains tax on future transfers. For tax purposes the concept of duality of purpose applies – if the place has two uses (home and office) HMRC will not allow it as an expense. The HMRC accept £4 per week without questioning it, or if you want to claim more than this sum, they demand to see relevant receipts and how this has been apportioned. (You might be challenged on your calculations.) An example. If it costs £100 to run your home, and it has two bedrooms, one of which you use as an office. If there are four rooms – you can claim 25% of £100 x 12 = £300. Then you need to determine how much of a 24 hour period is used for work – 8/9 hours of £300 would be about £260 p.a. if you are lucky – not far off £4 per week allowance. Expenses have to be listed carefully and evidence kept.
- Telephone. Take a reasonable judgment of what the actual use is. Check the normal everyday period, how much of it is private vs professional use. In the case of telephone bills, it is straightforward to apportion work and personal calls based on itemised phone bills. However, rental costs as with a landline (not so with a mobile) are less easy to claim as HMRC will cite ‘duality of purpose’ and disallow the expense. You can use one month’s bill to extrapolate for a year, but they will ask for the bill as evidence. It may be easier to use a separate phone for work purposes.
- Broadband. You may be allowed a small amount for emails if the plan covers for a certain data allowance. However, HMRC are intrusive in the way they investigate what you are using and claiming for. If you work from home and use broadband, you can apportion charges.
- Travel. Maintain a business travel log. Most people don’t travel more than 10,000 miles per year but you do need to keep a record of your business travels.
- Short contracts. If you travel one day a month but to the same business – that will become commuting unless it is for short contracts e.g. up to six months, in which case you might be able to prove that it is travel.
- Car. If you are not VAT registered, you can claim business mileage 25 per mile for the first 100 miles and 10p thereafter (the first rate takes into account depreciation). You can do it separately and then claim petrol at 12p per mile. You will need to keep a log book with detailed entries that it was business purposes.
- HMRC Toolkits. It is important to pay attention to the information on the HMRC website – i.e. use their toolkits. If you haven’t done the process properly and you can’t prove you used the toolkits, the time period for being investigated can be extended from 4 to 6 years and penalties go from 0 to 15%. Therefore, use toolkits and take notes of what you do to follow their process.
- Records. The HMRC is very hot on records and at the minimum, you need to keep records on a spreadsheet, unless you are using a digital filing system with a cloud-based mobile bookkeeping tool.
If your total business income is below £150,000 (total of earned and non-earned), you can put up to £40,000 per annum into a pension scheme.
Once the income exceeds £150,000 – the allowance reduces. For every £2 of income over £150,000, your annual allowance is reduced by £1, the maximum reduction being £30,000. So anyone with an income of £210,000 or more will have an annual allowance of £10,000.
There is a total limit to a £1,030,000 pot over the lifetime of an individual, mixing private and company schemes, unless protection was taken at an earlier time. If this sum is exceeded, there is a charge.
Letter of Wishes
Completing a letter of wishes is vital: you can nominate the person who will receive the pension pot, e.g. ‘I would like my pension [pot] to go to X’. This is very important: if you don’t have this in place, the trustees of the pension will give it to the executors and therefore become subject to inheritance tax at 40%. With a letter of wishes, held by the trustee, payments out of the pension pot will enable children to receive a tax free sum. Currently, there is no restriction on who the beneficiaries are, whether they are related to you or not. If you pass away or you reach the age of 75 years without having withdrawn sums from your pension scheme, the beneficiaries can take a lump sum or income with no inheritance tax but if they take an income or you are 75 years, your pension scheme becomes taxable.
If you have several pension providers, you need to send a different letter of wishes to each pension provider. Depending on whether or not you have taken income, the tax treatment from each pension scheme might be different.
7. Capital Gains Tax (CGT)
You’re in business as a lawyer. Should you sell your business and derive a benefit, the benefit would be liable to capital gains tax at the standard rate for companies of 20%. If in business (sole trader and partnership) and you able to monetise the business and sell it, you can claim Entrepreneurs’ Relief and a reduced CGT rate of 10%.
Special rules apply if you are set up as a limited company, as you have to qualify with more than 5% of the voting rights and more than 5% of the entire share capital. The 80:20 trading test will determine whether your company is mainly trading. There must be a minimum 12-month period before liquidation or claiming Entrepreneur’s Relief.
Getting Rid of a Company
The only permanent way of getting rid of a company is liquidation, not striking it off or making it dormant. If you are going to retire, your company has money in it and you want to get it out, you need to do a members’ voluntary liquidation. You will be able to claim entrepreneur’s relief on the resulting gains. Otherwise, part of the income might be liable to income tax.
You can also take a dividend out of the company every year, effectively using the reserves and receiving regular income.
Can you deregister the company for VAT?
If you have stopped trading, you can but you will still need to file annual company tax returns. If you want to stop all tax returns including VAT, you will need to liquidate the company.
8. Inheritance Tax
When you pass away, your company may or not have a value (cash reserves). There is an exemption of 100% from inheritance tax if you have a trading business, in the form of Business Property Relief (BPR). You can pass the business assets to children free of inheritance taxes and spouses can buy them back.
Note: Ensure there is no pre-ordained arrangement regarding what will happen to the business after your death otherwise, business property relief will not be available. An example. If other parties have an option to buy your business but there isn’t a binding contract written into the will, then business property relief will be lost.
9. HM Revenue & Customs Enquiries
You really do want to consider professional fee insurance, a voluntary fee protection insurance cover for someone to handle a revenue enquiry. It’s only a few hundred pounds and money well spent, as dealing with a revenue enquiry is very expensive in terms of fees. At roughly £350 an hour + VAT and 3 hours minimum to deal with a straightforward enquiry, any tax enquiry can quickly become very expensive. Note that payments to this type of insurance are not tax deductible. Some examples of fee Insurance are PFP, Qdos Vantage Croner Taxwise.
What is the HMRC looking at? Nowadays, the HMRC uses centralised computer systems and statistical information to find discrepancies and things that are out of the ordinary. Triggers for an investigation are things such as non-compliance, late filing of returns, errors that are subsequently corrected, out of the ordinary amount spent on travel. Or they are looking at business records which fall outside the ‘business norms’ they have a mass of statistical data and look at anomalies. Note that enquiries usually start with an aspect and expands to other areas of your tax profile.
If one person in the household earns over £50k and you receive child benefit, then it is treated as income. Good to know for single parents. Therefore, either decline it or take it and pay tax.
Talk to your professional advisor about passing shares in your company to your adult children when they go to university.
Domicile affects how you are taxed in the United Kingdom and results in specific rules of tax liability for worldwide assets. The various classes of relevant domicile are
- Domicile of origin outside UK – not pay tax (subject to rules) on non-UK income
- Domicile of choice – can elect for this
- Deemed domicile – tax resident for (currently) 17 years worldwide assets liable for IHT
You are deemed UK domiciled after 15 years and liable for worldwide assets for income tax and capital gains tax. If you have rental income in another country, you have to declare your income in the country of origin and in the UK but based on the provisions of the double tax treaty, you may deduct country of origin taxes from your UK tax liability. If are not UK tax domiciled yet and you have a domicile of origin that’s not the UK, it is possible to pay income only on the UK portion of your income but again, check your personal situation with a professional advisor. Events that trigger the declaration of overseas assets in the UK can include transfer of such assets or death.
12. Lasting Powers of Attorney and Wills
Most people, especially lawyers who know all about these, haven’t done them. It is imperative to have a will one as there is no right for partners to inherit, only statutory provisions enabling a challenge for dependents. It is a disaster if a parent ends up having a disease, a stroke, because without a power of attorney, courts will come in and things will become very challenging. Do it for yourself, for your spouses, talk to your parents.
Lasting powers of attorney affect assets in the UK and it doesn’t matter that you live in the United Kingdom during the whole year or only part of the year. In particular, lasting powers of attorney are very important as managing affairs via a public trustee is very time-consuming and to use professional advisers is expensive.
This is not an easy conversation, but it’s wisest to have a conversation about their own plans for the future. Ensure that they have a will in place and lasting powers of attorney. There is a financial lasting power of attorney and a health version. Know where these documents are kept and know the details of the accounts.
For more information and professional advice on tax, self assessment for freelance lawyers, you can contact Tim Cook.