Self-employment: Calculating income from self-employment

General rules
Actual receipts
Permitted expenses
HMRC cash basis
Digital service areas

Calculating income from self-employment for UC is very different to tax credits where claimants simply take the figure used for their tax return for the appropriate tax year and enter it on to the tax credits forms.

Income from self-employment will be taken into account as earned income for the purposes of calculating UC regardless of whether the person is found to be in gainful self-employment or not.

General rules

Earnings that are not employed earnings and are derived from a trade, profession or vocation are self-employed earnings.

Self-employed earnings must be calculated for the claimant’s monthly assessment period.

Where the claimant is in their first assessment period and a determination is needed before the end of that period about whether they meet the financial conditions for UC (set out in Section 5 of the Welfare Reform Act 2012) – an estimate of the amount received or to be received may be used.

Where a claimant fails to report their income for an assessment period and the decision maker makes their own determination as to the amount of earned income in that assessment period,  then the amount of earnings for that assessment period may be based on an estimate of the amount received or to be received.

Otherwise, the basic calculation is:

GROSS PROFITS minus INCOME TAX, NATIONAL INSURANCE AND PENSION CONTRIBUTIONS

Whilst this seems a straightforward calculation, there are some important points to bear in mind:

It is not possible to create a negative amount, if the income calculated using the formula above is a negative amount then earnings are to be treated as Nil.

Where the claimant belongs to a partnership, the amount of profit or loss taken into account is the amount attributable to their share in the partnership.

If the person has more than one trade, profession or vocation in the assessment period, then the gross profit for each business is added together before the deduction for tax, national insurance and any pension contributions are made. You cannot offset a profit from one business against a loss in another. For example if business 1 had gross profit of £500 in a particular assessment period and business 2 made a loss of £200, the gross profit for that assessment period would be £500. This is because business 2 would be treated as Nil as it is a negative figure.

Actual receipts

Any payment actually received during the assessment period is included as an actual receipt, regardless of when is it earned.

Example -

John is a painter. His month assessment period for UC runs from 10th of one month to the 9th of the following month. On 31 May, John carries out some painting work for a client for the agreed price of £300. The client pays John the £300 on 15 June.

For UC purposes the £300 will count as an actual receipt for his assessment period 10 June to 9 July even though he did the work and the money was earned in the previous assessment period.

Actual receipts are not defined in legislation but DWP guidance gives examples of the following items which are receipts:

It should be noted that capital receipts do not form part of the actual receipts of the business. For example, funds introduced by the owner of the business in order to finance the business or loan capital borrowed from third parties for financing purposes should not be counted as actual receipts.

For VAT, claimants have a choice of how they deal with receipts. The claimant can either report earnings inclusive of VAT and then deduct a VAT payment as an expense when it is paid to HMRC. Alternatively they can report the earnings exclusive of VAT and so no permitted expense would be allowed when payment is made to HMRC.

The ADM Chapter H4160 onwards provides further details about each of these payments, together with some examples.

Permitted expenses

Permitted expenses are amounts paid in the assessment period in respect of expenses wholly and exclusively incurred for the purposes of the trade, etc, or an identifiable business proportion of any expenses incurred for more than one purpose. In principle, DWP will deduct from the actual receipts any business expense that

Again, only expenses that are paid out during the assessment period can be deducted from the actual receipts even if the money is due to be paid in a different assessment period.

The ADM Chapter H4197 lists allowable expenses and provides more details about these conditions. Some examples of allowable expenses include:

A deduction can be made for a payment of interest in relation to a loan taken out for the purposes of the trade, profession or vocation, however this deduction cannot exceed £41 in the assessment period. This is a cumulative figure and covers the total interest payable across all relevant loans. This also includes interest on credit cards and overdraft interest and charges if the original expense related to the trade.

No deductions are allowed for:

In some cases, instead of deducting the actual expenses incurred in relation to the acquisition or use of a motor vehicle or expenses incurred using your home for business purposes, certain flat-rate deductions are allowed instead. The claimant can choose which method to use (Except in the case of cars as explained below) but if flat rate expenses are deducted, the actual expenses cannot also be deducted as follows:

For a car or van or other motor vehicle apart from a motor cycle

for the first 833 miles

45p per mile

 

thereafter

25p per mile

For a motor cycle

 

24p per mile

Note that for a car, the only deduction allowed for the cost of acquiring or running the vehicle is the flat rate deduction shown in the table above. In the case of a motor cycle or van, or other motor vehicle other than a car, the claimant may choose between the flat rate deduction (above)or the actual cost of acquiring and running the vehicle under the normal permitted expenses rules.

The definitions of car and motor cycle are taken from the Capital Allowances Act 2001. For these purposes a car means a mechanically propelled road vehicle but not a motor cycle, or vehicle designed mainly for the movement of goods or burden or any description or vehicle of a type not commonly used as a private vehicle.

A motor cycle is defined as a mechanically propelled vehicle, not being an invalid carriage, with less than four wheels and the weight of which unladen does not exceed 410 kgs.

At least 25 hours but no more than 50 hours

£10

More than 50 hours but no more than 100 hours

£18

More than 100 hours

£26

According to DWP guidance (H4224) income generating activities include:

- providing services to a customer
- general business administration essential for day to day running of the business (such as stocktaking, invoices, receipts)
- action to secure business (sales and marketing)

It does not include:

- using the home for storage
- time spent on completing tax returns for HMRC
- being on call or available to undertake work

Two examples from DWP guidance explain how this works in practice:

Fred is S/E and works from home as a music teacher. He uses the downstairs of the house as a music studio and lives upstairs. When reporting his income for the purposes of his award of UC, Fred says that he incurred S/E expenses relating to the home of £800 in his most recent assessment period. Fred shares his home with his civil partner, Andre. Andre is not involved in Fred’s business. Fred claims £800 in permitted expenses and reduces this amount by £500 as both he and Andre occupy the premises.

Victoria is a pub landlord. The downstairs of the building where she lives is the pub and she lives upstairs with her husband and two children. When reporting her expenses for her award of UC, Victoria reports expenses of £3,500 for the latest assessment period. Victoria decides that trying to apportion these expenses between the pub and home upstairs is not possible but is not sure what to claim. The DM decides that the permitted expenses should be reduced by £650 because there are three or more people occupying the premises.

HMRC cash basis

Claimants will be asked to provide evidence of their self-employed earnings. As accounts are generally prepared using accounting principles, they will often show different information to that required for UC purposes and claimants may therefore be asked to provide additional supporting evidence, such as bank statements, purchase receipts or indeed expenses from a different assessment period, to support their claim.

Providing self-employed income calculated on a cash basis for UC purposes present complications for claimants as there are key differences between the accounting mechanisms for income tax purposes and those for UC purposes, outlined below:-

 

Accounting under Universal Credit

Accounting under HMRC’s cash basis

Reporting time frame

Monthly reporting.

Annually by January 31 after the end of the tax year (although this may change under HMRC’s proposed digital strategy).

Mandatory or optional use of accounting basis

There is no choice on how the monthly accounts are prepared for DWP – they must conform to the Universal Credit regulations.

The cash basis is optional and eligible businesses can elect to use it on an annual basis. However, certain trades are not allowed to use the cash basis and there is also a turnover ‘exit’ threshold (see below). Alternatively, businesses can use the ‘accruals basis’ (generally accepted accountancy practice).

Thresholds

There are no thresholds – all self-employed Universal Credit claimants must use the same accounting basis.

Universal Credit claimants must leave the cash basis if their annual turnover is greater than £300,000

Transitional rules

There are no transitional rules; when completing their self-assessment tax returns Universal Credit claimants must adjust their annual accounts to ensure that income and expenses are only declared once.

On switching to the cash basis (and from it to the accruals basis), transitional rules ensure that income and receipts are accounted for only once.

Carry forward of losses

There is currently no facility to carry forward losses from one assessment period to another.

Business losses may be carried forward to set against the profits of future years but not carried back or set off ‘sideways’ against other sources of income (which is possible when using the accruals basis of accounting)

Digital Service Areas

Surplus earnings and losses: In digital service areas, it is expected that the UC rules will introduce a surplus earnings and loss policy in respect of income (The Universal Credit (Surpluses and Self-employed Losses) (Digital Service) Amendment Regulations 2015). These surplus earnings and self-employed losses rules were due to come into force from April 2016 for those claiming in digital UC areas but DWP delayed the changes until April 2017 (The Universal Credit (Surpluses and Self-employed Losses) (Change of coming into force) Regulations 2016). On 20 July 2016, a further delay was announced and the changes will now not be implemented until April 2018.

The basic principle is that if someone has a UC award terminated (for example because their income goes up due to a new job) a calculation will be done to work out their ‘surplus earnings’ for that month and the following five months. Surplus earnings are essentially the amount of income they have above the point at which their UC would reduce to nil plus a £300 de minimis. If the person then needs to reclaim UC within that period, say because they lose their job after four months, the surplus earnings for those four months will be applied to their new claim as income. This means they will receive either a reduced UC award or a Nil award and that will continue until the surplus earnings are used up. These surplus earnings will apply to both employed and self-employed claimants.

For self-employed claimants, some recognition for losses will also be introduced. The rules mean that a loss from the previous 11 months can be carried forward and used in an assessment period. However, the loss can only reduce income down to the level of the minimum income floor and it cannot take account of any pension contributions.

Updated 17 May 2017