As we alluded to in our article on the Rise of Tax Investigations, HMRC will soon be launching a campaign using web bots to trawl through e-marketplaces such as eBay, Etsy and Amazon. They will be targeting those who run businesses through such sites, but clearly there is scope for those who simply sell goods on a regular basis to be caught by the campaign.
At what point, though, does selling handmade birthday cards on Etsy or your services as a photographer constitute self-employment rather than just a hobby?
How do I know if I'm trading?
The line between hobbies and trading can be a blurred one. It is judged by several criteria known as the “badges of trade”. These include:
- Profit seeking motive
- Frequency and number of similar transactions
- Nature of the asset being sold
- Length of ownership of that asset
- Reason for the acquisition/sale of the asset
- Connection with an existing trade
Just one of these badges may be enough to show trading, but more usually a combination is considered. HMRC are most concerned with profit seeking motive as if there is no profit there's nothing to tax. Such a motive will arise when you seek to do more than simply cover the cost of your materials.
What are the tax implications?
If you have determined that you are trading you will be liable to income tax and National Insurance Contributions if you earn over certain thresholds. Even if these thresholds aren't met, you must inform HMRC within 6 months of the end of the tax year or you may be fined £100 for failure to notify. Registering as self-employed can be done by completing form CWF1 (pdf) or online. Once registered, you will need to complete a self assessment tax return by the 31st January following each tax year.
Any profit you make will be taxable if your total earnings (including any other employment) exceed the personal allowance (£7,475 for 2011/12). Whether or not you make a profit, though, you will need to record your income and expenses on your tax return. Assuming you complete this online your income tax liability will then be calculated for you.
If you make a trading loss then this can be offset against your other income for the year, or carried forward or back against income for other years subject to various rules. However, if HMRC determine that there is no profit seeking motive to your hobby they will disallow any losses from it.
Self-employed people are generally required to pay both Class 2 and Class 4 National Insurance Contributions (NIC). However, if you are earning below the small earnings exception (£5,315 for 2011/12) you can elect not to pay Class 2 NIC by completing form CF10 (pdf) and if you earn below the lower profits limit (£7,225 for 2011/12) you don't have to pay Class 4 NIC.
The rates for National Insurance Contributions are set out on HMRC's NIC page.
If your “hobby” has grown into a fully-fledged business you might have to start to think about VAT. If your turnover for the previous 12 months exceeds £73,000 (2011/12) or will exceed that amount in the next 30 days alone (perhaps due to a big order for your birthday cards) then you will need to register for VAT. This will usually make your goods more expensive for your customers (assuming they're not VAT registered themselves) but if so you will generally be able to claim back input VAT on your supplies.