Self-employment remains a very popular choice. In 1975, about 8% of UK workers were “solo self-employed” (ie sole traders or limited company owner-managers with no employees). However, by 2019, that percentage had risen to more than 14% (source: Institute for Fiscal Studies).
According to government figures, the UK now has 3.5m sole traders (the most common type of self-employment), making up almost 60% of the total UK business population (6m). Many sole traders are freelancers, contractors or agency workers earning their living in a wide variety of sectors.
The UK also has about 414,000 ordinary partnerships (7%) and like sole traders, ordinary business partners must also register for Self Assessment (the system HMRC uses to collect tax), as must landlords and others who earn additional income.
What records must you keep when you’re a sole trader?
You must keep financial records that detail your earnings/income/sales and costs/expenses as a sole trader. Not only can you then reliably complete your Self Assessment tax return and pay tax that you owe, but HMRC can also ask to see your records as proof of any figures entered in your tax returns.
You don’t submit your full financial records to HMRC, rather you summarise them in your annual Self Assessment tax return. HMRC then uses this information to work out how much tax you owe, after any allowances or Income Tax reliefs are accounted for.
HMRC does not have any hard and fast rules on how you must keep financial records as a sole trader. You can keep them on paper or create your own computer spreadsheets. However, using reputable accounting or bookkeeping software can save you lots of time and reduce the likelihood of mistakes.
Moreover, HMRC is in the process of digitising the UK tax system (Making Tax Digital), which will mean sole traders will need to report figures online to HMRC every quarter and finalise them at the end of the year. Finding bookkeeping software that is or will be MTD-compliant is recommended. From April 2023, you’ll need to keep digital records if you fall within MTD for Income Tax if turnover more than £10,000 a year.
Need to know! HMRC can charge you a penalty of up to £3,000 for failing to keep or maintain adequate financial records. Penalties for underpayment of tax can also be due.
What financial records must sole traders keep?
Sole traders must keep records of all sales made or income received, which may include till rolls for some and invoices for others.
They must also detail their running costs/outgoings/allowable expenses – which must be “wholly and exclusively” incurred for legitimate business reasons. Sales receipts and invoices should be retained as proof of purchase, even for seemingly minor purchases, because HMRC can ask to see these.
If you’re a sole trader and your “VATable” sales exceed the threshold (£85k a year), you’ll need to register for VAT and maintain detailed VAT records.
Sole traders can employ others, in which case they need to keep PAYE (Pay As You Earn) records. These must show that you’ve reported accurately and you need to keep them for three years from the end of the tax year they relate to. HMRC can check your records to make sure you’re paying the right amount of tax reported on the Real Time Information (RTI) submission.
Need to know! There are apps that allow you to use your phone to photograph and store receipts, which can make the process less arduous.
For how long should you keep your records?
You must keep your financial records for at least five years after the 31 January Self Assessment tax return submission deadline of the relevant tax year. At any time before that, HMRC may seek to check your records to make sure the figures are accurate and that you’re paying the right amount of tax.
So, if you send your 2020 to 2021 tax return online by 31 January 2022, you must keep your records until at least the end of January 2027.
The rules are different for very late tax returns. If you submit yours more than four years after the deadline, you must keep your records for 15 months after you file your tax return.
Need to know! If your records are lost, stolen or destroyed, you can either provide estimated or provisional figures (while you’re compiling actual figures. You need to tell HMRC this when filing your Self Assessment tax return.