Self-employment: Calculating income from self-employment

Step-by-step calculation
Actual receipts
Permitted expenses
HMRC cash basis
Unused losses

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.

Step-by-step calculation

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, following steps need to be carried out:

Step 1: For each trade, profession or vocation that the claimant is engaged in calculate actual receipts minus permitted expenses.

Step 2: Add together the amounts in Step 1 for each business (if there is more than one)

Step 3: Deduct amounts paid in the assessment period for income tax and national insurance. If the amount left is Nil or a negative amount - then the claimant's self-employed earnings are Nil. If the amount is greater than Nil, move on to Step 4. Note that where a negative amount is created, this can be 'banked' as an unused loss to be used at a later date under Step 5.

Step 4: Deduct any relievable pension contributions made by the person in the assessment period unless those same contributions have already been deducted in calculation their employed income.

If the amount left is Nil or a negative amount, then the claimant's self-employed earnings are Nil. If the amount is greater than Nil, move on to Step 5.

Step 5: Deduct any unused losses, taking the oldest first. If the amount left is greater than Nil - that is the amount of the person's self-employed earnings in respect of the assessment period. If it is Nil or a negative amount, their income from self-employment is Nil.

There are some important points to bear in mind:

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.

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

Carry forward of losses to future assessment periods is possible subject to the Minimum Income Floor. See our surplus earnings and losses page for more information.

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)

Unused losses

In full service areas, the surplus earnings and losses rules apply from 11 April 2018 onwards. See our surplus earnings and losses section for more information.

A person has an unused loss if there is a negative amount left after Steps 1 to 3 of the income calculation set-out above. This is after deduction of tax and NI contributions, but before any deductions are made for pension contributions.

A loss is no longer an 'unused loss' once it has been extinguished in a subsequent assessment period. This means that no amount of the loss remains after it has been deducted in Step 5 of the income calculation.

When a UC award ends, unused losses will normally be lost. However, the rules do allow the person to continue to carry forward their losses, and potentially accrue new losses, if they claim UC again within 6 months.

If a claimant was previously entitled to UC and the last day of entitlement in that (old) award fell within 6 months before the first day of entitlement in respect of the new award then the DWP can treat:

as assessment periods under the current award. This seems to allow unused losses from an old claim to be used in a new claim as long as the gap is no more than 6 months. It also allows any losses from months between the old and new award to be used as long as a claim for UC has been made. This would appear to require a person to continue making claims for UC (even if they may be entitled to nil) to protect any losses accrued in that 6 month period.

The Regulations state that this 6 month joining rule applies only if the person provides such information as the DWP require.

Last reviewed/updated 12 October 2018