This post follows the steps a brand new small crafting business (a made up person called Alice’s made up new venture making & selling fudge) takes to get her first year’s figures into their Tax Return, based on the issues about trading periods and the sorts of expenses we’ve covered so far – so it’s not complete by any means, but should give you a bit of help to understand how what we’ve covered operates in real life.
The example ended up quite long, so it’s in two parts:
- Today’s post covers how to deal with all the ‘normal running costs’ expenses – that is anything that’s not ‘stock’.
- The second part (available on Wednesday) will cover the ‘stock’ expense and a bit more on stock valuation, and getting the figures into the Tax Return itself.
Featured Seller: BrightStar 109 (Claire English) See her Etsy shop here
and about her work at the foot of this article
Alice’s actual business starts on the first morning she starts selling her fudge, say 1 June 2009. But for some time before, she works hard finding out about & testing to find good recipes, buying baking equipment & packaging etc, and finding out how much she can sell it for. She decides to sell fudge only online, making it to order. I know she needs to jump through various health & safety hoops to be able to sell food products, but I’m ignoring them – the reason I’ve picked Fudge made to order is because it has a fairly short shelf life which helps when we get onto the Stock Valuation issues.
She is a bit nervous about keeping her figures straight so she goes to the local newsagent and buys one of those Manual Accounts books that have spaces for all the income and expenses on a weekly basis, monthly summaries and an annual summary so she can keep her numbers straight. She wants to keep her business finances as simple as possible.
- Her commencement date is 1 June 2009
- Any money she spends before that date ie up to 31 May 2009 counts as Pre Trading Expenses (more on that below)
- She has to register as self-employed with HMRC by 30 August 2009 (3 months/ 90 days) after commencement to avoid the initial £100 penalty (and any additional penalties for late registration).
- At the same time she also applies for a Small Earnings Exemption for Class 2 National Insurance Contributions (covered later in the Series) because she doesn’t think she’ll be making enough money to exceed the threshold this year.
- She decides he wants to keep things simple and chooses a year end of 31 March 2010.
- Her first trading period will be 1 June 2009 to 31 March 2010.
- She also decides she doesn’t want to submit her 2010 Tax Return (based on her first trading period of 1 June 2009 to 31 March 2010) in handwritten paper form by 31 October 2009, because she’s intending to take time off between Christmas and New Year and do it then. So she goes to the HMRC website and registers for Online Tax Return Filing in the autumn so that there’s time for the Activation Code (it can take up to 21 days) to arrive in the post well before Christmas so that she’s got as much time as she needs to do her books and fill in the Return by the 31 January 2010 deadline.
- She has contacted her local Business Link business advice provider, and they’ve given her lots of useful information about running a small business, including sending her on an free seminar about tax run by HMRC and she was able to ask lots of questions to make sure she’s doing it right. She’s also looked at the Business Link website guide to starting up in business and the HRMC website’s Self Assessment and Self Employment sections for their guides on the nuts & bolts of what to do and when for her tax returns.
- She converts her PayPal account from a Personal one into a Premier one because now she's selling online. It doesn't cost her anything, means buyers can pay using their credit cards, and makes sure she's compliant with PayPal's rules.
First Year End 31 March 2009
Alice has filled in her Manual Accounts Book every week with
- the total income received, and how many portions were sold
- the amount of raw ingredients of sugar, butter, flavourings etc purchased to make the fudge batches and a note of how many batches were made (keeping track of batches and portions sold means she can keep track of how much of each batch was sold, and therefore work out whether she needs to make smaller or larger batches etc)
- any expenses incurred ‘wholly and exclusively for business purposes’ and keeps the expense receipts together in an envelope with a note on them of what it was for if it’s not already clear because she probably won’t remember later on.
She finds it easier to keep her Book this way because some of the raw materials, and the finished product are perishable so she has a fast turnover of stock whether she sells it all or not – she can’t just keep finished product in a box and not worry about when it sells like say someone who makes cushions or necklaces could. She’s also filled in the monthly totals and now she also does the Annual Summary and puts the Book away until after Christmas when she’s going to do her tax return.
She was going to make sure she has as few raw ingredients left over as possible on 31 March because she’s heard that raw materials/ goods for resale costs are claimed in her tax return on the value of what she’s ‘used’ not what she’s bought and she doesn’t want a stockpile of expense she can’t claim until later, especially if it might go off.
But, as it happens, there was a really good deal on raw ingredients on 31 March 2010 from a supplier she’d not used before, so she bought more than usual, and carefully made a note of how much raw ingredients she actually had unsold on the night of 31 March 2010 when she finished up for the day in the Book because she knows it matters for getting her stock expense claim right in her tax return.
Annoyingly, it wasn’t such a good deal after all, as a couple of days later (after the year end) her washing machine overflowed and flooded the cupboard she put some of the extra raw ingredients for the business in, and the flood destroyed them! Of course, by this time she’s started a new Manual Accounts book for her new trading year starting on 1 April 2010, and because she isn’t quite sure how the Accruals Basis will treat this disaster for her tax return, she makes a note about the stock loss in last year’s book to 31 March 2009 (year 1) and this year’s book (year 2) so she won’t forget.
Alice gets the Manual Accounts Book for her first trading period to 31 March 2010 and her receipts envelope out.
She has a quick look back through the Manual Accounts Book and remembers some other things that haven’t made it into the Book because they weren’t totally for business – like using her home kitchen to make the fudge and do her admin - or because no cash was involved.
She also has her Building Society savings book that shows that she’s saved most of her profits. Because she’s a sole trader, those savings don’t belong to the business, they belong to her personally, and the interest earned on them goes on her tax return in the Savings & Investments section not the Self Employment pages.
What matters for her tax return for the Self Employment pages are the cash income and cash expenses in her Manual Accounts Book, adjusted for the tax rules under the Accruals Basis for items that aren't just about cash in & out of her pockets.
- She’s already got her cash income figure total ready in her Manual Accounts Book.
- Looking through the Manual Accounts Book, she sees a note that on Valentine’s Day 2010 she took some portions of fudge for a giftbox for her husband (an Appropriation). She didn’t pay herself any money for the fudge, so the full retail value of that fudge needs to be put in a special box on the Self Employment Tax Return pages called ‘Goods & Services for your own use’. If she had put any cash into the takings for that day, the difference between what she paid and the full retail value would go into that special box on the Return. Because the full retail value of goods taken for own use is always declared (regardless of the actual cash you paid out for taking them), you never make any adjustment to the stock side of taking those goods out, because that would cause double-counting and make your figures wrong.
- She’s already got her expenses figures as weekly, monthly and annual summary totals in her Manual Accounts Book, but it’s the cost of buying the raw ingredients (stock) and everything else mixed together. She’ll do it differently next year to keep Stock expenses as a separate sub total and everything else as a separate sub-total as she goes along, but for now, she’s got to redo it from the weekly pages: because whilst those Book totals are a good total for seeing how her business has done over the year to see her cashflow, they’re not the figures she needs for tax.
- She adds up the costs of all the expenses on items like an apron to protect her clothes, tea towels, washing up liquid, baking tins, packaging, online selling (Etsy listing and selling fees) and banking (PayPal fees) and so on, from the weekly pages together. Anything that passes the ‘wholly and exclusively’ test that isn’t a stock expense.
- She also has a look at how much it costs to run her home for the period – heat, light, gas, phone etc. And works out a reasonable proportion of those costs that applies to the time she’s spent there running her business in the period, to claim as an expense (more on exactly what can be claimed later in the Series).
- She has a Pay as you Go Phone just for the business, she topped it up before the year end, and hasn’t used all the credit yet, but includes the whole cost as an Accrual as she’s paid for it before the year end, so she adds all the business phone top-up costs for the year (including the half used one) to claim as well.
- She also looks at her costs of running the car and having kept a mileage record for the business related trips, works out what proportion can be claimed for business use.
- She also looks at the notes she made about expenses she incurred before her commencement date (Pre-Trading Expenses). She separates out the expenses that relate to raw materials (stock), and ignores them until she gets to her Stock Valuation calculation later. She looks at the rest of them, works out which ones can be claimed as 'wholly and exclusively for business purposes', and the proportion of which ones can be partly claimed by splitting the cost between business & private use. Then she adds these non-Stock Pre-Trading Expenses to her other 'normal running costs' expenses.
- The final total of these claimable non-Stock expenses is her ‘normal running costs’ expense claim.
Which feels like a very good place to stop this article. Wednesday’s article will follow on from this one and be about how she works out her allowable ‘stock’ expense, and the sort of issues she needs to consider to put a reasonable value on what she’s got at the year end in her annual Stock Valuation which includes:
- Raw materials ie actual raw ingredients
- Unfinished product (ie fudge made but not yet packaged)