11th December 2019
This question is not unfamiliar to me. The full question is normally along the lines of ‘Why is my tax bill so high, in fact why am I paying any tax at all?’
I do understand the thinking from a sole trader’s perspective, I think it is a sentiment shared by us all. But the simple fact is we live in a tax-based society and however you structure your personal and commercial affairs, you will always have to pay some tax, whether you are a sole trader, limited company director or partner in an LLP. After all, you have had the benefit of the income.
I normally find that the question being posed has originated in a pub or around a meal table and stems from the fact that ‘my mate is paying less than me but our circumstances are the same’. They rarely are the same though and these kinds of discussions tend not to deep dive into the details, focusing instead on a high-level summary of turnover and take home.
When one drills down on two ‘similar’ scenarios it is often very easy to see what creates the variance in income and tax. Firstly, do the ‘years’ being discussed cover the same period? Tax allowances change in April most years and the year in question may refer to the last 12 months, the last tax year or the last accounting year and the odd percentage point here and there will make a difference. For this reason and due to the natural fluctuation in income and expenses too, year-on-year comparisons are not a good baseline when considering tax. Low expenses and increased income means more tax – simple.
The other dimension rarely considered is personal circumstances and elements that can impact your personal tax allowance. For sole traders these may include how you pay for vehicles, pensions, healthcare and other non-financial benefits. Expenses and allowances that are available to claim for directors are not necessarily the same for the self employed and vice versa. Your mate may be putting away ten times what you are into his pension which can be offset against his profits, reducing his taxable income. You may have a different tax code to them meaning you can earn more/less than they can before tax becomes payable. They may even have other incomes such as rental properties or shares which pay dividends. So beware the quick comparison. Despite what HMRC say on their adverts, tax is taxing and I don’t think I can name any two clients whose circumstances, and therefore tax bills, are even closely aligned.
Whoever you are and whatever you earn, any tax bill hurts, so I always try and put a positive spin on the end of any discussion with a sole trader/client regarding the size of their tax bill. I do this by pointing out that in most cases a big tax bill means you have enjoyed a good level of income and generated a nice profit margin. It’s sometimes all too easy to lose sight of that fact.