1. Are you self-employed?

1.1. Establish whether you will be classed as self-employed.

This will depend partly on the trading form you choose and partly on how you organise your work. Think carefully about whether or not to form a limited company and review this decision at intervals.

You are self-employed if you are your own boss and trade as a sole trader or as a partnership.

If you trade as a limited company, you, as a shareholding director, are an employee of the company. You are not classed as self-employed.

See Choose the right form of business.

1.2. Check your position carefully if you work full-time for a single company as a consultant or contractor.

A tax inspector is unlikely to treat you as self-employed unless you can show you:

• Control what you do, and how and when you do it.
• Have more than one customer.
• Bear an element of business risk.
• Have a right of substitution.

2. Pay tax and ni as a self-employed person

2.1. You must register as self-employed within three months of starting your business.

Contact the HM Revenue & Customs Helpline for the Newly Self-Employed on 08459 15 4515.

HM Revenue & Customs will change your tax status to self-employed and arrange for you to pay the correct National Insurance contributions.

Remember that you can be self-employed in one job but employed in another.

2.2. Work out the annual profits made by your business.

The self-employed pay income tax on the profits they make - not on their drawings. For example, if you make £30,000 profit, you pay tax on the full £30,000 - even if you have drawn only £10,000 as salary and have retained the other £20,000 in the business.

The same income tax bands apply to sole traders as to employees.

Your profit is your revenue less allowable expenses, excluding your salary (see section 4).

You usually pay tax on the profit of a 12-month accounting period which ends in that tax year.

2.3. You can offset trading losses against any other income received (earnings from a job, revenue from investments), plus any capital gains arising in that year.

Alternatively, losses can be carried forward to offset against future profits from the same trade. Losses in the first four years, or in the last year, may also be carried back up to three years.

2.4. Set up an accounting system to help you calculate your taxable income.

You will need to keep suitable records and receipts, cheque stubs and other evidence that is required by law.

See Set up and maintain your books.

2.5. You must fill in a self-assessment tax return which will be sent to you by HM Revenue & Customs in April.

You need to complete all the information on taxable income, gains and tax allowances.

If you submit your form by September 30, HM Revenue & Customs will work out how much tax you owe.

If you calculate your tax liability yourself, or in conjunction with an adviser, you have until January 31.

2.6. Ensure you pay your tax by the correct dates.

After your first year in business, tax is due in two equal instalments: on January 31 (during the tax year) and on July 31 after the end of that tax year.

Interim amounts payable are based on the previous year's tax liability. If profits are falling, it is possible to reduce the payments.

A balancing payment is then due on the following January 31 to adjust for the difference between the amounts paid and the tax due as a result of the actual profits.

2.7. Calculate the Class 4 and Class 2 National Insurance contributions (NICs) you must pay.

Class 4 contributions are collected by HM Revenue & Customs at the same time as income tax. These are eight per cent on profits between £5,225 and £34,840, plus an additional one per cent on annual profits above £34,840. There is no longer an upper limit on how much a self-employed person can pay in NICs.

Class 2 contributions of £2.20 a week (£114.40 a year) must be paid to the National Insurance Contributions Office. Direct debit is the simplest and most trouble-free method of payment.

Someone earning less than £4,635 a year (excluding any start-up grants) can apply to be exempted from Class 2 contributions. Ask for Form CF10.

If, as well as working as a self-employed person, you also have a job working for an employer, you will still be paying Class 1 contributions. In this situation, you can apply to defer payment of the Class 2 and Class 4 contributions.

2.8. It's a good idea to consult an accountant or tax adviser.

They can help you ensure you pay the right amount of tax and complete your returns correctly. They can also provide you with tax-planning advice.

3. Tax for a limited company

3.1. You must register your company with HM Revenue & Customs and set up a company payroll.

Contact the HM Revenue & Customs New Employer's Helpline on 0845 6070143. You will receive a starter pack which explains how to set up a payroll and when to file forms and make payments.

3.2. As a director you are an employee of the company and pay income tax every time you are paid.

Income tax is deducted at source from all earnings above your personal income tax allowance through the company payroll under PAYE (Pay As You Earn).

Any overpayment or underpayment of tax is corrected after you complete your tax return at the end of the tax year, which runs from April 6 to April 5.

3.3. You must also submit a self-assessment tax return as a director.

Make sure you keep forms showing your pay, benefits in kind and tax paid, and information on expenses claimed.

If you submit your form by September 30, HM Revenue & Customs will work out how much tax you owe. If you calculate your tax liability yourself or in conjunction with an adviser, you have until January 31.

You will probably only need to make one payment of any tax you owe in addition to that paid through PAYE. This is due on January 31 following the tax year.

If you owe less than £2,000 and submit your return by September 30, this can be collected through PAYE.

3.4. As an individual you also pay Class 1 National Insurance contributions (NICs) on your earnings.

These are deducted through the payroll along with your income tax.

For the 2007/08 tax year, Class 1 NICs are 11 per cent of weekly earnings between £100 and £670, plus an additional one per cent on weekly earnings over £670. But lower rates apply to employees who are members of a contracted-out occupational pension scheme.

3.5. The company must pay employer's National Insurance contributions (Class 1A) on employees' pay.

This is 12.8 per cent for employees earning more than £100 a week, with no upper earnings limit. Again, lower rates apply for contracted-out employees.

The employer's contribution is an allowable expense (see section 4).

3.6. Your company must pay corporation tax on its profits.

A company's profits are its sales less allowable expenses, plus investment income and chargeable gains. Expenses are covered in section 4.

There are two corporation tax bands according to the level of your profits:

When profits fall between £0 and £300,000, and between £300,000 and £1.5m, you are eligible for marginal relief. This is designed to ease the transition from one rate to the next. The limits are reduced for companies belonging to groups.

3.7. You must work out your own corporation tax bill and ensure you pay it on time.

Small and medium-sized companies (with profits of up to £1.5m) have to pay corporation tax within nine months and one day of the end of their accounting period.

Your first accounting period begins when your company starts trading. Your accounting periods must not be longer than 12 months but don't have to mirror the tax year.

You must complete a corporation tax return within 12 months of the end of the accounting period. This is normally sent to you by HM Revenue & Customs.

You can offset trading losses against all other income in the accounting period. Alternatively, the loss can be 'carried forward' against profits from the same trade, to reduce future tax bills, or 'carried back' and offset against profits from the previous year. The company can be reimbursed for tax already paid.

You can request form CT600, the corporation tax return, by calling HM Revenue & Customs on 0845 300 6555.

3.8. Remember that all profits paid as dividends to non-company shareholders are now taxed at a minimum of 19 per cent.

However, the zero rate remains if profits are re-invested in the business.

4. Working out your business expenses

4.1. You can count business costs as expenses when working out your profit figure.

These include:

Goods and materials, including anything your business buys in and then resells. The allowable expense will be affected by the value you place on stocks at the year end. A common mistake is to value stock at its selling price, rather than cost. This inflates your profit figure and increases your tax bill.

Directors' and employees' wages in a limited company, pensions, and employer's National Insurance contributions.

Premises costs, such as rent, rates and heating.

Selling costs, including marketing and advertising expenses.

If you work from home, HM Revenue & Customs usually allows a fair proportion of your gas, electricity, water, telephone and council tax charges to be counted as business expenses.

Finance costs, bank charges and interest (including leasing and hire purchase interest).

General running expenses, including telephone, insurance, transport, travel and subsistence (eg hotel costs on a business trip), stationery, postage, accounting and other services.

Capital allowances (see section 5).

Spending on research and development.

4.2. You cannot count personal and some other costs as legitimate business expenses.

These include:

Personal costs such as living expenses, ordinary clothes and travel to and from your regular place of work.

Entertaining - including any food or drink bought for clients.

Certain professional fees - including the costs of forming a company and the costs of obtaining a lease.

Depreciation - instead, you claim capital allowances (see section 5).

Fines - including parking tickets.

4.3. Ask for a full list of allowable expenses from your accountant or from HM Revenue & Customs.

Remember that the self-employed can claim a wider range of expenses than employees.

4.4. If you are not registered for VAT, treat the VAT element as part of any expense you claim.

If you are registered, VAT is reclaimed separately.

4.5. From the moment you decide to go into business, keep records - with matching receipts, invoices and bank statements - of all your business expenditure

Most of the costs you incur on research and setting up the business are usually allowable as business expenses in the first year provided you have formally notified HM Revenue & Customs that you have started a business.

Set up a separate bank account to make this easier.

Some costs are not allowable. For example, training courses are only an allowable expense once you have officially commenced trading.

If you form a limited company, the formation costs incurred will not be allowable.

5. Claiming capital allowances

5.1. You cannot claim for purchases of premises and equipment as a business expense - instead you claim capital allowances to deduct a proportion of their cost from your taxable profits.

Capital allowances can be claimed by both limited companies and the self-employed.

Most are spread over a number of years and often gradually reduce.

Allowances range from zero to 100 per cent, depending on the size of your business and what you are purchasing.

5.2. You can claim an allowance of 25 per cent for some equipment - though there are higher rates for small and medium-sized businesses in the first year

Currently, small businesses can claim a first-year allowance of 50 per cent. The allowance for subsequent years is 25 per cent.

Small businesses are those with two of the following: turnover not more than £5.6 million a year; assets not more than £2.8 million; not more than 50 employees.

A small business purchasing a piece of equipment worth £8,000 at the main rate could reduce its taxable profits by £4,000 (50 per cent of purchase price) in the first year.

In the second year, the allowance is 25 per cent of £4,000, the remaining value of the item. This means £1,000 can be deducted from taxable profits.

In the third year £750 can be deducted - 25 per cent of the remaining value of £3,000. In this way the value of the capital allowance gradually decreases year-on-year.

5.3. Remember that special rates or conditions apply to certain types of equipment.

Businesses buying low-emission cars (emitting up to 120g/km of carbon dioxide) can claim 100 per cent first-year capital allowances. For other cars the 25 per cent rate applies, but a maximum allowance of £3,000 a year can be deducted per car.

There are also 100 per cent first-year allowances for energy-saving and environmentally beneficial equipment.

Visit www.eca.gov.uk for details of capital allowances on energy-saving equipment.

5.4. You can deduct an allowance of four per cent for qualifying industrial buildings.

You deduct this proportion of the original cost of the buildings each year.

5.5. Claim your capital allowances when completing your income tax self-assessment or corporation tax self-assessment form.

To simplify matters, all equipment subject to the 25 per cent rate (except cars) is generally lumped together in a 'pool', with capital allowances calculated at 25 per cent of the total value.

If you are not registered for VAT, you can also claim capital allowances on the VAT that is charged on the equipment you buy.

5.6. Time your purchases so that you buy any equipment before your year-end.

If you make a purchase the day before your year-end, you still receive the full capital allowance for the whole of that accounting period.

You can also defer capital allowances in some circumstances.

6. Company cars and tax

6.1. If you are a self-employed person using your own car for work, you can claim expenses in one of two ways.

You can estimate the percentage of miles travelled for business purposes and claim this as an expense. You must provide sufficient evidence to back up your claim. Whenever your car is serviced, make sure the mileage reading is noted on the bill. You can also claim a percentage of the capital allowances if you own the car.

Alternatively, you may be able to claim an allowance in line with HM Revenue & Customs Approved Mileage Allowance Payments scheme.

6.2. If you are an employee of a limited company, you can usually claim a mileage allowance.

If mileage allowances are paid in line with HM Revenue & Customs Approved Mileage Allowance Payments (AMAP), there is no extra liability. If they are greater than AMAP, the difference is taxable.

AMAP for all cars (and vans) are 40p a mile for the first 10,000 miles, and 25p a mile thereafter.

6.3. You must pay income tax on the benefit if you use a company car for private purposes - and the business must pay employer's NICs on it.

Calculation of the benefit is based on the list price of the car and its carbon-dioxide emissions.

If fuel is provided for private use, this is also subject to tax and employer's National Insurance as a benefit, based on a fuel charge. The charge is based on the same percentage used for the car benefit and is applied to a fixed amount determined each year (£14,400 in 2006/07).

7. Registering for and paying vat

7.1. Value added tax (VAT) is a tax on sales of goods and services.

All businesses pay VAT on most purchases. This is called input tax.

If your business is VAT-registered, you charge VAT on the goods and services you sell. This is known as output tax. If you receive more output tax from sales than you pay in input tax on purchases, you pay the difference to HM Revenue & Customs (HMRC).

7.2. You must normally register for VAT as soon as you supply goods and services worth £64,000 a year or more (2007/08 tax year).

You must notify HM Revenue & Customs within 30 days of the end of the month if your taxable sales in the last 12 months exceed this limit.

You must also register if you expect sales in the next 30 days alone to exceed the £64,000 threshold.

Exceptionally, you can ask to remain unregistered if you expect sales to fall back below the threshold.

You can register before you start trading if you wish, so that you can reclaim VAT on pre-trading business expenses (see section 4). You must give HM Revenue & Customs evidence of your intention to trade.

To register online, visit the HMRC website or contact the helpline on 0845 010 8500.

7.3. If your sales are below the registration threshold, check whether it would be worth registering voluntarily.

This could be worthwhile if you pay a higher-than-average amount of input tax and charge a lower-than-average amount of output tax.

7.4. Check which VAT rate applies to your goods and services.

Most goods and services are standard-rated supplies and are currently taxed at 17.5 per cent.

A few supplies are charged at a reduced rate of five per cent. These include: domestic fuel or power; installation of energy-saving materials; children's car seats.

Supplies taxed at a zero rate include: most food; children's clothing; books and newspapers. If you make zero-rated supplies and are registered for VAT, you do not charge customers VAT on sales but you can claim it back on your purchases.

Supplies which are exempt from VAT include: insurance; providing credit; some education and training services. If you only make exempt supplies, you cannot register for VAT or reclaim input tax.

7.5. Start charging VAT on sales as soon as you are required to register - do not wait until registration is complete.

For the time being, add 17.5 per cent to your prices - or less, because you will be able to offset VAT charged against the VAT you will save on purchases.

Don't show the VAT element on invoices yet - explain to customers that you will send out VAT invoices once you are registered.

7.6. Keep full and accurate records for VAT.

You must provide a VAT invoice for every sale to a VAT-registered customer - and keep a copy yourself. It must contain your VAT number and the rate and amount of VAT charged.

Keep all the VAT invoices for the purchases you make.

Record all input tax, output tax and payments to HM Revenue & Customs in your accounting records.

Copies of invoices and VAT returns must be kept for at least six years. HM Revenue & Customs can ask to visit you to check your records.

7.7. Ensure you submit your VAT returns and pay any VAT due to HM Revenue & Customs on time.

You must submit a VAT return for every accounting period. This is generally every three months - but you might want to consider using an alternative accounting scheme for VAT.

Your return, together with any VAT you owe, must be with HM Revenue & Customs by the end of the month following the VAT period.

7.8. Consider whether other VAT-accounting schemes may be appropriate for your business - your accountant will be able to advise you.

The flat-rate VAT scheme is designed to reduce the amount of time businesses spend accounting for VAT. You can use it if your annual turnover subject to VAT does not exceed £150,000 and your total annual turnover does not exceed £187,500. VAT is charged as a fixed percentage of your VAT-inclusive turnover depending on your type of business. Individual transactions are ignored.

Cash-accounting is available to businesses whose annual taxable turnover does not exceed £1.35 million. Under this system, no VAT is paid on a sale until you have been paid for it, which can be useful if you have slow-paying customers.

Annual accounting requires one VAT return to be filed a year, with provisional VAT payments based on an estimate of the year's turnover. Any business with an annual turnover under the threshold of £1.35 million can use the system from the date of VAT registration. The leaving threshold is £1.6 million.

8. Capital gains tax

8.1. You may have to pay capital gains tax (CGT) on successful investments, such as those in property and shares.

If you sell something for more than you paid for it, you may be taxed on the capital gain. This is the difference between the item's value when you dispose of it and when you acquired it, less certain types of allowable expenses.

Understanding CGT can be particularly important if you're aiming to build up a business and then sell it on.

8.2. Individuals, including the self-employed, generally pay capital gains tax at the same rate as income tax.

Capital gains are added to any other income, to determine what the top rate should be.

Gains falling within the middle rate band are charged at 20 per cent, rather than 22 per cent.

The first £9,200 of capital gain each year is tax-free. A husband, wife or civil partner can each claim this allowance.

CGT is payable on January 31 following the end of the tax year in which the gain is made.

8.3. Check what exemptions you may have from CGT.

These include gains in ISAs and increases in the value of your principal private residence and private cars.

Under certain conditions, some investment vehicles, life-assurance policies and charitable gifts can also be exempt.

8.4. Limited companies pay corporation tax on any capital gains.

Capital gains are treated as part of the company's taxable profit.

8.5. You can set any capital losses against capital gains from the same tax year and carry them forward against future capital gains.

8.6. Check whether you are eligible for taper relief on business assets.

Many types of shares in businesses qualify for taper relief. If you hold qualifying shares for at least a year, the proportion of any gain you are taxed on falls to 50 per cent. After two years or more, it falls to 25 per cent of the full rate (effectively, ten per cent for a 40 per cent tax payer).

9. Reducing your tax bill

9.1. Consider delaying incorporation if you expect to make a first-year loss.

A self-employed person can offset the tax loss against previous years' employment income and receive a tax rebate. The business can still be incorporated later.

But being self-employed has other important implications - including unlimited liability for business debts.

9.2. If you are making profits, and your cashflow is sound, you may want to reduce your profit at the end of the year in order to reduce your tax bill.

Consider asking sound, established customers to delay purchases from you until just after the year end.

Bring forward the purchase of items of equipment that you will have to buy later anyway.

Make full provision for specific bad debts.

9.3. Payments into a pension scheme can be an efficient way of saving tax.

Never make such business decisions for tax reasons alone.

Tax is just one consideration. For example, putting money into a pension scheme to save tax is unwise if the cash is really needed to run the business.