I have an extensive guide on my blog that covers every aspect of registering a business – either as a sole trader or a limited company, which you can find here: Tax and Business Registration for eBay Sellers.
Now one of the main parts of that guide is how to simplify your accounting process – after all there’s no point in starting a business if you have to spend hours upon hours every week updating complicated spreadsheets and P/L accounts…
And today I want to expand on that a little bit and introduce you to Cash Basis accounting.
There are two main types of accounting used – cash basis and traditional. If you’re a sole trader (which as discussed in my guide you really should be unless you’re in the higher rate tax bracket) then I strongly suggest you use cash basis accounting for your business.
In case you’re unfamiliar with the terms, the main difference between cash basis and traditional (also known as accrual basis) accounting is that for cash accounting your income is only calculated on actual payments received and money spent. Whereas for traditional accounting you have to record income and expenses when you make a sale or receive a bill, regardless of whether or not the money has actually been exchanged.
Cash basis accounting is something that HMRC have only started using fairly recently, and you’re only eligible for it if:
- You are a sole trader or partner
- You have an income of £83,000 or less a year
This means that if you’re a Limited Company then you have no choice but to use traditional accounting.
But as the vast majority of you are sole traders/partnerships, this isn’t a problem – plus I always suggest finding a good accountant to help with everything once you do register as a Ltd. Company anyway, as it’s just not worth trying to handle it all on your own.
Alright, now that we’ve covered what cash basis accounting is and why you should be using it, let’s move on to the end of year Self Assessment and what tax you have to pay!
Now I’m not going to go into registering for Self Assessment and the process behind filing your yearly tax return, as I’ve covered this in great detail in my main tax guide, so once again please check that out if there’s anything you’re confused about.
What I do want to talk about is how your taxable profit is calculated, and most importantly what business expenses you can claim back.
Put simply, you taxable income is calculated by taking your turnover (i.e. sales) and then subtracting your expenses (i.e. cost of goods, import taxes, eBay & PayPal fees, postage costs etc.) to leave you with a profit – which is what’s then taxed.
The exact tax rate depends on the level of profit, and while this changes slightly every year, it’s currently:
But also remember that you get a Personal Allowance each year, which is the amount of income that you don’t pay any tax on. The Personal Allowance is currently £11,000 so you should deduct that from your income to get your actual taxable income.
Here’s a quick example if this is all a bit hard to understand:
Joe Bloggs is filing his Self Assessment tax return and he has total sales for the year of £60,000.
From this figure he removes £23,000 for total expenses, leaving a profit/income of £37,000.
However he then also has to remove his Personal Allowance of £11,000 – leaving a final taxable income of £26,000, which as you can see from the above table falls into the Basic Rate bracket and is taxed at 20%.
Now we’ve finally reached the main point of today’s post – deducting expenses!
As the above example has shown, how much you can deduct as expenses is very important as it lowers the amount of tax you have to pay at the end of the year.
That’s why I get so frustrated when I see people only deducting their most basic expenses; like stock, import taxes, shipping and fees. You’re just leaving money on the table like this (well more accurately, leaving money in HMRC’s bank account)!
But of course this doesn’t mean that you should go and buy a holiday and then deduct that from your sales, because that’s not a business expense – in technical terms it’s not an allowable expense.
Here is a full list of costs you can claim as an allowable expense as a sole trader using cash basis accounting:
- Things you buy to re-sell, e.g. stock or raw materials
- Office costs, e.g. stationery or phone bills
- Staff costs, e.g. salaries or subcontractor costs
- Clothing expenses, e.g. uniforms
- Travel costs, e.g. fuel, parking, train or bus tickets
- Financial costs, e.g. insurance or bank charges
- Business premises costs, e.g. rent, heating, electricity, business rates
- Advertising or marketing, e.g. domain, hosting, SEO, flyers
I hope you’re starting to see why it’s 100% worthwhile to keep proper records so that you can claim all of your businesses expenses and save yourself a hefty amount in tax every year!
One of the main questions I get when it comes to deducting expenses is for items that are used both for business and personal reasons – most people seem to think that you can’t claim these back at all, but the actual answer is that you can only claim allowance expenses for the business portion of these costs.
What does this mean?
Well let’s say I spend £300 on my phone bills for the year, and £200 of that was calling customers – well then that means I can claim £200 of my phone bill as an allowable expense.
Or if I spend £25 a month on ink for my printer – roughly £5 of that is used for personal printing and the rest is for eBay invoices and packing slips – that means £240 (20 x 12) of allowable expenses from printing costs.
Of course not everything will be as easy to divide – for example if you work from home, then what proportion of your utility bills and rent can you deduct as a business expense?
HMRC don’t actual give us exact rules here, but they do state that “you’ll need to find a reasonable method of dividing your costs, eg by the number of rooms you use for business or the amount of time you spend working from home.”
They then go on to give us an example to illustrate what a reasonable method of calculation would look like:
“You have 4 rooms in your home, one of which you use only as an office.
Your electricity bill for the year is £400. Assuming all the rooms in your home use equal amounts of electricity, you can claim £100 as allowable expenses (£400 divided by 4).
If you worked only one day a week from home, you could claim £14.29 as allowable expenses (£100 divided by 7).”
And this same sort of thinking can be applied to basically everything – all your utility bills, your property insurance, rent and even your mortgage interest (but not the principal repayment).
The same goes for your vehicle – if you’re using it for business use (driving to the post office, visiting suppliers, going to your nearest port etc.) then those portions of your cost can be deducted as allowable expenses.
Now I know what some of you may be thinking at this point: “Okay, this sounds great Andrew, but HOW am I going to work this all out!? Isn’t it a bit too complicated when it comes to dividing total costs into personal and business use!?”
Well I personally don’t think it is (but then again I do have an accountant to take care of all of this for me, so maybe I’m not best placed to judge!).
However, you’re in luck as there is another method of calculating business expenses using flat rates instead of having to work out what percentage of the costs are for business and personal use.
This is known as Simplified Expenses and you can use these flat rates to calculate the business costs of:
- Working from home
- Living in your business premises
- All other expenses have to be calculated by working out the actual costs.
I’m going to ignore point 3, “living in your business premises” as that won’t be applicable to many online sellers.
Let’s delve in a little to the other two so that you understand how they work.
The overall process for using Simplified Expenses is incredibly, well, SIMPLE! All you need to do is:
- Record the number of miles driven for business for your vehicles and record the number of hours you worked from home.
- At the end of the year use the flat rates for vehicles and working from home to work out your expenses.
- Include these amounts in the total for your expenses in your Self Assessment tax return.
It’s as simple and easy as that!
And here are the flat rate amounts so you can judge whether or not they’re worthwhile compared to your actual expenses:
So if you drove a car for 12,000 business miles in a year, that would mean:
- 10,000 x 45p = £4,500
- 2,000 x 25p = £500
- Total claimable = £5,000
And for working from home, it is:
And that’s it!
The decision of whether to use simplified expenses or to work out the actual costs for yourself will depend on two factors:
- The amount of work involved
- The difference in allowable expenses
HMRC have very kindly provided a calculator that you can use to see whether or not it’s worthwhile to use simplified expenses for your business, so I strongly suggest you go through that and get a definite answer:
And that pretty much brings us to the end of today’s post! I hope you have found this guide to claiming expenses useful, and I look forward to hearing some stories of people saving thousands of pounds on their next Self Assessment! 🙂
Until next time!
All the best,