Trading income allowance: What it is and how it works in the UK

Are you thinking of leaving paid employment to start your own business? Then the Trading Income Allowance would interest you. What is the Trading Income Allowance, and how can you enjoy the benefits in the UK?

Around 2016, the UK government came up with a plan to encourage more start-ups and entrepreneurship businesses, and the plan gave birth to what is called the trading income allowance. The trading income allowance became active in April 2017, it enables business owners to not pay any tax on the first £1000 of their self-employed income.

An individual can earn an income from side jobs or through self-employment and be entitled to tax rebates on earnings less than £1,000. You may ask: What if I earn above £1000? Well, there is also a provision for you, and we will cover all the possibilities in a moment.

Industrialization has been helpful in grooming economies, but there have been the demerits of underpaid staff. Since most of these paychecks are not enough to take care of their expenses, many workers must put up with miserable working hours and unbearable working conditions. The response of most governments of the world (not excluding the UK) was to put a structure to protect the interest of its citizens in the form of minimum wages.

Since most people did not have to work miserable hours anymore, the room for innovation was opened, and there was a surge in the number of creative ideas that could help people meet others’ needs while earning passively.

According to a survey from DailyMail in 2021, about 68% of UK residents have a secondary source of income. Some of the passive income includes writing, podcasting, selling handmade candles, renting out a flat/space or even selling handmade clothing/accessories. The importance of these small businesses cannot be overemphasised, and the trading allowance offered by the UK government is probably a sign that they recognize the role these businesses play in the stability of an economy.

What exactly is the trading allowance?

The Trading allowance is any amount from £1 to £1,000, which you can use to reduce the tax accruable from income made off self-employment. This way, taxes from side jobs’ profits can either be null or reduced. Side jobs can range from trading and hobbies to the sharing economy and even freelancing employment.

While there are sometimes you are better off not using the trading income allowance, if your total gross income from your side job is less than £1,000 in the taxable year, it would be to your advantage to use the trading income allowance instead of a tax return.

You cannot use the trading allowance if you have a partnership or limited company.

Help!! I have a trading income of not up to £1,000

You can claim full relief from your tax returns if your total gross earnings for the year are less than £1,000, as the annual gross trading income is covered by the trading allowance. With a trading income of £1,000 or less, you don’t have to report the income to HMRC, file a tax return or complete a self assessment tax return unless you want to.

A trading income allowance example is that of John. John is a teacher that found out during the Covid lockdown that he loved gardening. His neighbours love his flowers, and soon enough, he got orders from them to help them design their Builders Yard. Those gross income from these orders totalled £980, and so expectedly, John would be required to fill a tax return.

Instead of filing a tax return, since his gross income for the year was not up to £1,000, John can use the trading income allowance. This way, he has full relief on his earned £980, which is not taxed.

What now happens to the remaining £20 from John’s trading allowance? Would it be returned to him?  The trading allowance is not a means for free money. Rather, it is meant to encourage the entrepreneurial spirit. For this reason, it cannot create a tax loss (having an income less than £1000 such that the government would have to initiate a tax refund).

Other noteworthy inclusion with under £1,000 gross earnings from self-employment:

• you can still enjoy the benefits of the trade allowance even if you did not trade for the full year.
• Even though there might be some other occasion for you to complete your tax returns, you don’t need to include the revenue that was entirely covered by the trading income allowance.

My trading income is well above £1,000. Can I enjoy the trading allowance?

While most of the aforementioned words have covered individuals whose annual gross income does not exceed £1,000, it is important to note that individuals with gross income that exceeds £1,000 can also get a tax deduction. This process is called partial relief.

The concept of partial relief is to create a form of equality such that entrepreneurs who earn more than £1,000 can also have some form of tax rebate.

The normal procedure for calculating taxes here is that you remove your expenses from your gross income, and the remaining money is taxed. With the trading income allowance, the process is slightly different. Your trading allowance is removed from your gross income (instead of your expenses), and the rest is taxed.

When claiming partial relief, you can not claim other allowances or business expenses. You can use the trading allowance one time, even if you have more than one trade. It can be favourable to claim business expenses and capital allowance to produce lower taxable profit than to claim the trading allowance, especially if you have a high expense and low trading income.

However, you must register for self assessment if your annual gross trading income is over £1,000. You have to contact HMRC if your other gross income is between £1,000.01 and £2,500, and you have to complete a self assessment tax return if your other income is over £2,500. Also, you may have to complete a tax return for other income.

Examples of trading income allowance.

Rita made £4,400 from her fashion design business. The expenses incurred on her business is a sum of £300. The expense deducted from the revenue will net her a profit of £4,100 (£4,400 minus £300), which will then be taxed. With a gross income of over £1,000, how is the trading allowance taxes reduced?

The £1,000 trading allowance is removed from Rita’s £4,400 gross income made from her fashion design business. So, her profit is calculated as £3,400 (£4,400 minus £1,000).

Other Noteworthy inclusions with over £1,000 gross earnings from self-employment

• Unlike the full relief from proceeds below £1,000, you need to complete a form on the tax return section of the HMRC on self-assessment of your trading income to be eligible for self-assessment trading income allowance

Unlike the fully covered trading allowance relief, due to reasons such as universal credits, it would be in your interest to report every income that is covered by the trading income allowance.

FAQ

When should you contact HMRC regarding trading allowance?

You should contact HMRC regarding trading allowance when your gross trading income is under £1,000  and can’t use the allowance, and when your gross trading income is over £1,000. Also, when other gross income is over £1,000 but under £2,000, and other income is over £2,000.

Trading incomes do not apply to?

The trading allowance does not apply to trading income from partnerships.

What is a trade allowance example?

Suppose you run a gardening business and made £2,300 in income during the tax year and have expenses of £300. You can claim the trading allowance of £1,000 instead of your business expenses of £300 as you can’t claim both. So your taxable income will only be £1,300 instead of £2,000.