Understanding income can be complex if you are self-employed.
In this blog, we talk you through what lenders expect in regards proving income – and how you can get ahead of the curve by ensuring you have the right figures and documents in advance of your mortgage application.
There are two common types of self-employment:
- Sole traders, where the business funds and owner funds are essentially considered the same
- Limited liability partnership or company, where the business’s funds are legally separate from the owner’s
Sole traders simply move funds around as required, whereas limited company directors must take a salary and dividend, and the figures are usually determined by an accountant.
In addition, whilst sole traders submit just one personal return, things become complicated further still for limited companies. Not only does a tax return need to be submitted by the limited company, but the directors themselves are also required to submit personal returns.
As a rule, lenders are only interested in personal returns, and they are looking for the gross amounts declared to HMRC. They will calculate the net income based on that tax year’s threshold and rates.
You can submit a personal return in one of a few ways:
Through an accountant, who submits the return to HMRC on your behalf, or through a self-assessment. Either way, once your return is submitted what’s known as your Tax Calculation (or SA302) is made available to download on the HMRC website.
If you haven’t already signed up for the Government Gateway, a service that handles the logins for the HMRC amongst other government services, it’s highly recommended that you do – and the sooner the better. This involves sending a code to you by post, which takes around a week to arrive.
To further complicate the process, not only do you need the document that shows the income declared to HMRC, but you also need a receipt for the tax paid too. As a result, for any income you wish to use, the tax owing must also have been paid. The document that proves payment is called a Tax Year Overview.
The reason for this is that you can easily re-submit as many tax returns as you want. For example, you could put through an income of £300,000, print the document and then re-submit as an income of £30,000 and pay the appropriate tax on the latter figure. Clearly, lenders want to be sure that the figure you are showing is indeed the final version and isn’t going to change.
Coupled with this, self-employed Tax Calculations are often not accepted by lenders if they cover a period more than 18 months ago.
Both of these points present a problem that is common at this time of year. Your personal return is due by the end of January, and the tax must be paid by then. The period covered in this return would be the April to April ending the previous year. So, in December, we often have a situation where the last return submitted and paid was the year prior to that – April two years ago – and would be older than the 18 months required by lenders.
Essentially, you may have to complete your return and pay the tax in the last quarter of the year as opposed to the following January. If you are doing a lot of mortgage borrowing I would recommend working to this schedule. Your accountant might also thank you for not leaving it until the last minute!
To summarise, if are self-employed and need to prove your income to a mortgage lender, you will often need 2–3 years’ worth of Tax Calculations to hand. These will need to have been paid, and you will need to download the Tax Year Overview for each year to prove this. If you are borrowing in the latter quarter of the year, your last fully submitted return might be too old and you will likely need to complete your return earlier than the January when the return is due.
You can very easily download these documents online if you have access to the Government Gateway and have registered for self-assessment. If you haven’t, your accountant will have done this for you and will be able to supply Tax Calculation and Tax Year Overview documents, and you can tick these tasks off your list before 2019 rolls around.
You can also find out more about proving your self-employed income here.