Tax Doctor:
Mark McLaughlin
CTA (Fellow) ATT TEP

Have you got a tax question? Post it on the Tax Tips Forum and it may be answered either by Mark McLaughlin or one of the other Forum contributors.

November 2005

Q:

I have not declared any income for the last 5 years, or paid any tax or National Insurance contributions, from a small home-based business part-time that I have run. I have studied concurrently for the last 5 years. I hope to operate this business on a full-time basis soon. Is there any chance that HM Revenue & Customs won't ask questions about my history when I declare myself 'newly' self-employed or is that purely wishful thinking? Any advice other than 'own up' would be greatly appreciated.

A:

I appreciate that 'own up' is not the advice you may wish to hear, but that is exactly what you should do! There are many people in the same position as you (sometimes referred to as 'ghost traders' or the 'black economy'). I expect that most set out with good intentions of doing the 'right thing' but simply never get around to notifying the tax authorities, until it gets to the point where they think it is too late. My advice to those people is always the same – seek professional help now in minimising the damage by bringing your tax affairs up to date.

To answer your question, it is possible that HM Revenue & Customs (HMRC) may not 'ask questions' about your self-employment over the last five years, but that will only be because they are not immediately aware of it. If you register your self-employment with HMRC, one of the questions that you will be asked is 'When did your self-employment commence?' Presumably, you would answer that your self-employment commenced when you started operating the business on a full-time basis. That is a false statement, which could lead to prosecution.

Paying large amounts of tax, interest and penalties for late disclosure of your self-employment to HMRC is an understandable concern. However, things may not be as bad as they seem. For example:

• The fact that you were a student whilst operating the business part-time suggests that you had no other sources of income. If that is the case, you will have your personal allowances (£4,895 for 2005/06, slightly lower for earlier years) to offset against any profits you made in each tax year. Any excess profits are taxable at the 10% starting rate, 22% basic rate, and (but only if the business was particularly successful), the 40% higher rate of income tax.
• However, many businesses make low or no profits in the early years of trading. If trading losses have arisen, they may be used in a number of ways, depending on the circumstances. For example, unused trading losses may be carried forward against future profits from the same trade.
• National Insurance contributions (Class 2 and Class 4) are both payable by the self-employed. However, there is a lower limit for Class 4 purposes (equal to the above personal allowances), and also a 'small earnings exception' profit limit (£4,345 for 2005/06), below which Class 2 contributions are not due (although not paying Class 2 contributions can have a detrimental affect on the future entitlement to state benefits).
• There is a requirement to notify HMRC of self-employment for Class 2 National Insurance contributions purposes within 3 months following the end of the month in which trading commenced. The penalty for failing to notify is £100. However, no penalty is charged if profits were below the threshold at which Class 2 NIC becomes payable up to the date of registration. For the tax years you have been self-employed, the small earnings exception' limit was between approximately £3,800 and £4,200 per year. HMRC also have discretionary power to waive this penalty.
• Even if you made profits in earlier years such that tax (and National Insurance contributions) is payable, 'owning up' could save you money, and could even save you from prosecution. Whilst HMRC can prosecute for serious fraud or the fraudulent evasion of income tax, this is much less likely if you disclose your previous self-employment before they discover it. This means that HMRC would instead seek a monetary settlement involving the unpaid tax, plus interest and penalties. The level of penalty is based on a percentage of the tax not originally declared. In theory, the maximum level of penalty is 100% of the tax. However, in practice this penalty is mitigated depending on the level of co-operation, whether you make a full and complete disclosure, and the size and gravity of the offence. HMRC will send you a leaflet explaining how they calculate penalties, and the extent to which you can help to reduce them.

I normally end each 'Tax Doctor' by recommending professional advice based on personal circumstanc????6?es. This is particularly relevant in your case. I would strongly recommend that you obtain expert help. An accountant or tax adviser who is experienced in cases involving 'back duty' should know how best to approach the situation and to deal with HMRC. This should be done sooner rather than later.

Mark McLaughlin

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