If you’re self-employed you are essentially seen as not being paid by the business. Instead you are entitled to draw against the profits that the business makes. As such even if you, the owner of the business, draw down no wages, you may still pay income tax.
Why is this?
To put it simply, you must pay income tax on the profits of the company.
Let’s consider the following:
You are self-employed and have made taxable profits of £21,000.
You have enough in your savings account elsewhere to support yourself for a full year, so you decide not to draw any wages at all.
Despite having no wages your income tax will be calculated against the profits of the company that year, thus you can expect to pay around £3,000 or more in income tax plus NIC contributions.
Remember, you’re taxed on your taxable profits not your drawings.
The next year, your business makes £21,000 again but you decide to draw a wage of £10,000. Since the profits of the company are still deemed as £21,000, you will be taxed on this again – don’t forget that if you have any expenses or capital allowances on purchases of equipment for the business then this can potentially be deducted from your taxable profits.
Finally, how about the final year? Let’s say that you traded for 5 years, always retaining profits in your business. In your last year you only make around £12,000 profit but have accumulated profits after tax of £20,000 in your bank account. On the last day of trading you transfer this full amount to your private bank account. This time however, since you have no tax to pay in your final year, there is no tax to pay and so you get to keep the full amount.