But what about the taxman?

The guide below is an introductory note intended for those who aren't familiar with the phrases used by the law and other official channels. It is only a guide and it is not legal advice. Any definitions are meant to be an indication rather than exhaustive meaning.

Trading

The most straightforward legal form  to own a business is to become a sole trader.

A sole trader is a person (an individual) who earns income from exchanging cash for goods (stuff) or services (doing something for someone else).

If you are a UK citizen and you earn income in the UK it will be liable to tax. The first step to becoming a sole trader is to register as self-employed with Her Majesty's Revenue & Customs (the taxman). This can be done online or by post.   An agent (such as an accountant) can do this for you, however before they may act for your legitimately, you must authorise them to do so by notifying HMRC using the correct form (http://www.hmrc.gov.uk/individuals/iwtauthorise-an-agent-to-act-on-my-behalf.shtml)

In becoming a sole trader, you are able to enjoy all profits (that is, the money which has been earned and left over once all expenses (outgoing bills) are paid). The flipside is that you also incur the risks. The liability (that is the amount your finances remain open to be claimed) is unlimited. If your business goes into debt, assets such as your house or car, or possessions even, could be sold in order to pay your debts - and this won't be a choice you get to make. This is because the law treats you as an individual, and you as a business, as the same thing.

Accounting and VAT

If you go into business, you must keep track of where your money comes in and goes out. This can be set up using a spreadsheet - keep it simple to start with. You will be given notice of self-assessment (the government will not add up how much tax you owe for you) and fill in the tax return when its due. You must also take note of VAT.

VAT (value added tax) is a tax added to some goods and services. In order to charge VAT on your goods/services you must first register with HMRC. Until your turnover reaches the threshold (around £70k for the last 12 months or in the coming month) you can decide whether you would like to charge VAT to your customers. Obviously, by not doing so, your customers can enjoy lower prices. However, once your turnover (sales figure is money in before expenses) reaches that level (or is likely to do so in the next month), you MUST register for VAT. On the plus side, if you undertake voluntary registration (that is before it becomes compulsory by virtue of the threshold) you can claim back VAT which you have paid out in the course of your business.

For example: Say your business is recuitment. On every candidate you place within an organisation, you can charge VAT on that placement. VAT is charged at 20% currently (Feb 2011) so on a £5000 placement, the VAT is £5k x 20% and add it together: £6k. Sounds fantastic apart from the fact that you have to give £1,000 to the tax man. However, if during the same period for VAT (most businesses will calculate VAT returns quarterly or annually) you have bought items for the office which had VAT charged on them (so you have to incur a higher price), you may offset (take away) that amount against the VAT for the placement. It will only be the balance of the VAT that you pay to HMRC.

Basically, VAT coming in (eg from a placement) - VAT which has gone out (on expenses) = balance paid to HMRC. As ever, all this must be documented with receipts and filled out on a VAT return.

Although you may take money from your business to use personally, you need to keep track of it. Any monies taken out for personal use will be counted as drawings (personal income) and you will be taxed on this income.

Record keeping

With every aspect of the business, it is important to keep good records. HMRC has extensive powers. Keeping up to date and on time is crucial. Late payments or submisson of returns can incur fines and penalties. Not just one off payments but interest on late payments which can quickly mount up. Inefficiency and ignorance are NO EXCUSE.

That means all sales and expenses must be recorded and evidenced (ie. with invoices and receipts) and kept together, orderly and transparent. Best practice is for the records are clear and easily recognisable. Copies should be kept for several years, at least five and to be on the safeside - more. Tax Inspectors can open a case investigating a business which can go back several years. General advice is err on the side of caution!

All these processes are your responsibility to undertake. They will always be your responsibility to undertake them. If you outsource these responsibilities to someone (to a professional person such as an accountant, this does not preclude that you take all reasonable steps to ensure it happens. If a professional person neglects their duties as your agent, you can sue them for negligence and may be able to claim compensation.) I wouldn't let it get that far. If you are lazy and disorganised with your own life (paying bills, keeping promises) your business won't last.