This could be a very long answer – one can virtually write a book about this subject (indeed, people do!). I assume that the starting point is that you are currently working full-time and will go down to three days a week. PAYE will operate so as to make sure you get the correct amount of tax deducted as your salary decreases (always assuming you have the correct tax code to start with!) for the year.
National Insurance Contributions (NICs) will also reduce but as NICs are calculated on a weekly standalone basis (as opposed to the cumulative nature of PAYE) there wouldn’t be any question of a rebate.
Turning to your new business, you should notify HMRevenue & Customs within three months of starting to trade - I assume you will be trading as yourself, i.e. as self-employed, rather than through a limited company. That will no doubt result in them registering you for Class 2 (self employed weekly) NICs and also marking you down for self assessment tax returns, if you don’t get them already. There is a ‘small earnings exception’ for NICs, currently £5,075: which means that if your profits don’t get to this level you opt out of Class 2 NICs. You are also potentially liable for Class 4 NICs on profits above £5,715.
NICs do get a little involved if you are both employed and self employed – there are maximum contributions and it may be that after the year you have a claim for a rebate, depending on your Class 1 (employed) NICs.
You don’t have to pay income tax on the income of your business immediately in a PAYE-like manner though - in principle income - tax liabilities start to accrue as soon as you start to trade assuming you make a profit. You’ll have to draw up your accounts and make a return of the income to HMRC. The self-employed normally pay their taxes in three instalments:
- The main liability is due by 31 January after the tax year (ie after April 5)
- But there is normally a requirement to pay two payments 'on account' on 31 January in the tax year and 31 July after the tax year.
These payments on account are based on the tax bill for the preceding year, so you’ve probably already guessed that in the first year or two of trading tax payments can be a little odd. Suppose you start business on 1 July this year; the profits you make in the 9 months to 5 April 2011 will be taxed in 2010/11 and the tax will be due to be paid on 31 January 2012. Among other planning and managing issues will be a need to put money aside to meet the tax bill – it can come as a bit of a surprise after a lengthy interval!
I should also mention VAT – if you think your turnover will get over the VAT threshold (now £70,000 per year) you have to register for VAT; if you don’t think it will you can still register if you want to. Finally, a couple of practical issues. Firstly do keep proper records (including receipts etc) so proper accounts can be prepared and/or your tax return supported. Secondly, have a look at the Government’s Business Link website – there is a lot of good information aimed at people starting up in business.
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