Sunday, 2 January 2011

TSCB 1 - When will the Revenue be interested in me?

The first thing you need to know is that the way you are taxed in the UK depends very much on particular circumstances: if you fall into one set of rules, you're taxed differently to falling into another set of rules.  It's very important that you understand that the rules are cumulative, your facts need to fit the rules in the order HMRC has laid down, you can't just jump ahead and think 'oh yeah the second bit applies so the result is for me' - nope ALL of it has to apply: and the rules can be quite intricate, so you ALWAYS need to go and do the extra reading before taking a decision on anything I'm writing about!

So, the first question you need to ask yourself is whether or not HM Revenue & Customs (HMRC for short) are going to be interested in you selling your stuff.  The answer depends on what sort of stuff you are selling and what your intentions are - are you a hobbyist or a trader?

In a nutshell:

A trader is someone who intends to make a profit from goods they intend to sell - having bought them for that purpose or bought supplies and made products from them for that purpose.  For example, buying material to make cushions to sell at craft fairs or online to make more money than the materials cost.  Traders are liable to Income Tax and Class 4 National Insurance Contributions based on their profits and a set rate of Class 2 National Insurance Contributions.

A hobbyist is someone who makes things for friends and family and just charges them for materials costs.  For example, buying cloth to make cushions to give to family for Christmas or making cushions to match your friend's new curtains, but you charge less than the materials cost.  They don't need to declare any income or losses to HMRC.

A non-trader is someone who is merely selling things they already own, that they bought for themselves and only later decided to sell.  For example, decluttering your house and selling the items on eBay.  They don't need to declare any income or losses to HMRC, but they might be liable to Capital Gains Tax.

HMRC are not interested in hobbyists, nor are they interested in non-traders who are just decluttering their houses.  They are however very interested in Traders (and any non-traders liable to Capital Gains Tax).

Beware, it's not where you sell the items that matters, it's what your intentions are when you sell - you can be trading or non-trading on eBay or any other website/ craft fair etc. 

Also, you can still be Trading even if you don't actually sell anything, or make a loss when you do sell - a loss arises when the price you sold it at is lower than the cost of your materials & time involved in making it (more on Losses later in the Series).
But, life isn't so clearcut is it? 

Let's say you start off learning your craft, and you buy supplies and you make things for friends and family.  Then other people start asking you to make things for them, or you think you might be able to make money selling online etc.  When do you change from being a Hobbyist to a Trader?  Also, what if you carry on doing stuff for friends and family as well as starting to sell to the general public?

Changing from Hobbyist to Trader: broadly speaking, you are trading from the date you put your first item up for sale to the general public with the intention of making a profit. 

Your commencement date for trading is not the date you make your first sale (unless you happen to make a sale on the first day you offer your items), and all your activities leading up to that first offering for sale are called 'pre-trading' (more on Pre-Trading Expenses later in the Series) and you need to keep the two periods separate in your mind.

A couple of final things to remember are that you can have a dayjob (employed or self-employed) AND a separate craft business; HMRC usually look at your craft business by itself without reference to the rest of your financial affairs to decide whether or not you are trading. 

You can also continue to make items for friends & family as a hobbyist at the same time as having a craft business - if you don't keep separate materials for each, then you'll need to know about Appropriations (in accounting speak) to keep your numbers straight for the trading side (more on Appropriations later in the Series).

Ok, I think I'm trading, what now?

What action to take: 

AMENDED 1: 4/5/12: [Original] You need to tell HMRC that you are trading within 3 months of the date you started to trade.  You do this by registering on the HMRC website for both Income Tax and Class 2 National Insurance Contributions (NIC), after you've read the HMRC guidance to Online Selling which starts here.

[New] There is now a new regime for penalties for failure to notify - which means that Form CWF1 is no longer a 'statutory' requirement for income tax, although it is still the mechanism HMRC use for people notifying them about Class 2 NIC.

There are now different deadlines depending on different circumstances - so much for tax simplification!

For income tax:

If you don't already complete a tax return, then you must notify HMRC of your new self-employment by 5 October following the end of the tax year of commencement of your self-employment.  Either by Form CWF1 or by letter, HMRC prefer people to use the Form.

If you do already complete annual tax returns then you must notify HMRC of your new self-employment on your tax return - either paper version by 31 October, or electronic version by 31 January following the end of the tax year.

Beware!  If you wait until 5 October, HMRC may not be able to issue the Unique Taxpayer Reference (called the UTR) you need to file your return by either 31 October (not crucial as long as you know your National Insurance number) or 31 January (can't file electronically without a UTR).

For Class 2 NIC:

Class 2 NIC is NOT dealt with through tax returns.  It is dealt with by Form CWF1 or letter and separate contributions records within HMRC to your income tax Statement of Account that matches liabilities and payments.

You must notify HMRC of your liability to Class 2 NIC by 31 January following the end of the tax year of commencement of your self-employment.

However, if you are entitled to claim an Exception Certificate - I would expect this to be for Small Earnings (the level changes every year, it's £5,595 now) although there are other reasons, like certain benefits or maternity allowances which also entitle a claim - then because HMRC can only backdate the Certificate to 13 weeks before an application - if you want to be exempt from Class 2 NIC from your commencement date, you need to file the Certificate claim within 3 months of commencement.

If you don't file the Exception claim on time, then HMRC will assess you for periods they think you owe them Class 2 NIC (currently £2.65 a week).  You either have a choice of paying up, or proving them by 31 January following the end of the tax year that you qualified for the Exception.  They will then repay any overpaid Class 2 NIC to you.

Beware! If you have claimed Job Seeker's Allowance (and some other benefits) this will be deducted from the repayment of Class 2 NIC they make to you - which may make the repayment claim not worth doing.

I am therefore sticking with my advice to make sure you've looked at registering for income tax and Class 2 NIC and register within 3 months on Form CWF1 because then you will avoid all penalties, excess tax and NIC charges and the hassle of having to battle with HMRC to get it all straightened out if you miss one or some of the different deadlines. [End New Amendment 1]
In the HMRC guidance on Selling Online, there is a list of sections on the left hand side covering the issues HMRC think you need to consider, the examples are very useful and the 'Badges of Trade' section gives a list of the actual triggers to indicate trading status.  In the 'Further Advice' section you'll find a link to the CWF1 form you need to use to register for Income Tax and Class 2 NIC. 
AMENDED 2: 4/5/12: [Original] If you don't register by the necessary deadline, HMRC will impose an initial penalty of £100, which can get bigger the longer you leave it.  [New] Broadly speaking, this only applies for failures to meet a deadline occurring up to 31 March 2010 for income tax and 31 March 2009 for NIC; for failures to meet a deadline occurring after 1 April 2010 for income tax and 1 April 2009 for NIC, the penalty is tax-geared ie maximum 100% of the undeclared liability.

In addition to the simple penalty of 100% for missing an initial deadline, there are 3 further occasions when an additional 5% (each) is charged - on any liability remains outstanding 30 days, 6 months and 12 months after it was due to be paid.  At present, HMRC do not appear to be applying the penalties automatically nor consistently, and my best advice is to avoid the whole area by making sure you  register well within the earliest deadline that could possibly apply to your situation (ie within 3 months of starting to trade or as HMRC put it 'as soon as possible') [End new]

What else might I need to know?  Well,
  • you might be able to apply for an exemption for Class 2 NIC if you think your profits are going to be below the threshold (more on NIC later in the Series - AMENDED 3: 4/5/12 now discussed briefly in the Amended Section on Registration above - called Small Earnings Exception).
  • sometimes HMRC say that someone isn't trading for income tax, but making individual or repeated profits on individual assets, which attract Capital Gains Tax.  This is unlikely to apply to anyone with a small crafting business, but it could apply if you sell high value vintage items.
  • HMRC might accept you are trading at first, but if you keep on making losses, they might downgrade you to a hobbyist.  Whilst that's great because you won't have to file returns & pay tax, it's not so great when it means you can't offset your crafting losses against your other income (more on Losses later in the Series).
  • You've identified your commencement date - the next thing you need to do is identify your annual trading period and year end so that you know which income and expenses to put into what tax year.  So, Trading Periods and Year Ends is the next post in the Series.
Finally, I'd be interested to know whether you think this is too complicated or too simplistic, covers too much ground or not enough, and whether it's easier to read because it's chatty or not?

PS - Addition 26 January 11: I've just done a posting on this Etsy thread here about what happens if you're more than a hobby but genuinely less than a business - you might be able to declare income as Other Income on your return (Box 16 on page TR3 of the paper return).  BUT be very careful of doing this, make sure you've got it right - if in doubt, register as self-employed.  Eventually I'll turn the Etsy thread posting into an article, but I thought it was worth highlighting here now for people who are neither fish nor fowl!

PPS: A question asked elsewhere has caused me to revisit the area of the deadlines for registration for Income Tax and Class 2 NIC for the self-employed, and of penalties - the amended areas original & new text are highlighted in RED above.  I originally intended not to update articles for new law, but as on further consideration, the new law was already in force at the time I wrote the article, albeit of no practical interest to anyone looking ahead to future deadlines rather than backwards to missed deadlines at the time of original writing.  The new rules are now VERY relevant a year later.  Therefore, I have amended this one.  I doubt it has added clarity, but hopefully I have added accuracy!

The new penalties regime has been brought in piecemeal, and unless HMRC caught up with a taxpayer (ie had already opened an enquiry into a taxpayer's affairs - in which this blog is not the place they should have been looking), pretty much the first time the new penalties would be seen would be when the taxpayer voluntarily completed their outstanding tax returns for the years running up to the year ended 5 April 2011 ie after 31 January 2012 (given that most people do a catchup of earlier returns at the same time as the year they're supposed to be doing in time for an approaching deadline).  The actual paperwork showing the penalties from such a taxpayer would probably first appear from HMRC in March or April 2012.

Apologies for not making this clear originally.  At the time I wrote the article, the tax profession and HMRC were still working through the ramifications of how and importantly, when, the new penalties would apply.  In retrospect, I can see my trying to keep it simple was counter-productive!  Because of the changes it remains a complex area that has not yet been fully played out time-wise in all circumstances, so be very careful that you are not missing deadlines if you want to avoid penalties.

I still stand by my advice to register within 3 months of commencement as it takes a lot of administrative hassle out of the process, gives HMRC time to issue the paperwork required and ensures any application for NIC exemption is made in good time.


Dotty said...

I think it is pitched just right and i'm looking forward to making sense of all these issues! Thank you

coldhamcuddlies said...

Excellent break-down and informative too. In my case, am a pensioner, in receipt of Pension Credit and pay no tax at all! Also, am definitely a Hobbyist, so think I'm all clear! Many thanks for relieving my mind on the score. All I'm seeking to do is go sell enough to pay for a trip over to France to see family members! Long way to go! Isobel

Judy's Crafty Moments said...

Gosh, I am so glad I found you. this is what I have been looking for all my life....well the past year! You are now bookmarked and I am going to read through your series bit by bit, learning as I go along. So many, many thanks for this wonderful series.

i love the fact that you tithe your income. I am a christian and we tithe my husbands income but never thought of doing my own. What a wonderful God honouring thing to do. You have certainly challenged me today!
Thanks again,
Judy x

Anonymous said...

Great information and easy to understand, do you have any advice on records which need to be kept.

Goblinf said...

Again, apologies for the lack of reply. An article on record keeping is in the pipeline as it's an often overlooked by the trader, and key area that HMRC criticise when they look into someone's tax affairs.

In the meantime:
Basic information about record keeping on HMRC website here
Specifically for the self-employed here

thanks for the interest!

Vp Associa said...

You have shared a great information about HMRC Capital Gains Tax and
HMRC Investigations
.Which are very informative for us. Thanks

Catrin said...

I'm already registered self-employed, and for Class 2 NI, as I operate as a freelancer for my day job - do I need to notify HMRC of anything now I've started an Etsy shop? Or do I just add my Etsy profits to my Tax Return?

(I'm additionally confused because I am yet to fill out a tax return for my day job, so I'm not sure exactly what the form looks like!)

Thanks for your help, this series is really useful :)

Nidhi said...

Thanks for the detailed information. Helps a lot!

I am very soon going to start my part time business. I already pay my taxes for my full time day job and obviously have a NI number too. Now, if I were to register as a small business, would it be okay to give the same NI? Or would I have to register my business on a different NI?
Sorry if this sounds foolish. I am lost!