Sole Trader - Definition, Advantages, Tax Responsibilities

When starting a business in the UK, it's important to understand the various business structures available.

As a freelancer, contractor or small business owner, there are three main types of legal structures you should consider:

• Sole proprietorship
• Limited company
• Working through an umbrella company

A sole trader, or sole proprietorship offers simplicity and independence for individuals starting their own ventures. In this comprehensive article, we will understand the sole trader meaning, examples, advantages, disadvantages, characteristics, registration process, and tax responsibilities for sole traders. Let's first understand what is a sole trader.

Sole Trader Meaning

A sole trader, also known as a sole proprietorship, refers to an individual who owns and operates a business as a self-employed entity. Sole traders are the sole owner, meaning they control all decisions and keep the profits after taxes. However, they are personally responsible for any debts or losses the business incurs. This business structure is simple to set up, making it a popular choice for small businesses and freelancers.

While sole traders are often considered a one-man business organization, it’s important to remember that the term ‘sole trader’ refers to the business structure - not the number of employees. While a sole trader trades alone and is self-employed, it doesn’t mean he or she performs the day-to-day operations alone without hiring employees.

Here are the key features of a sole trader:

1. Full Control

As a sole trader, you have sole ownership and full control over your business. You are your own boss. You don’t need to consult with directors or shareholders before deciding. You are entirely in charge of a wide range of business decisions - from running your operations to how you want to grow your business or use your profits.

2. Continuity

Continuity relates to the point above. As there isn’t a legal distinction between the owner and the business, a sole trader depends on its owner. The company will cease to exist depending on the owner’s circumstances, such as death, retirement, bankruptcy or imprisonment.

3. Taxed as an Individual

A sole trader pays income tax - not corporation tax - on taxable business profits, and they are also required to pay Class 2 and Class 4 National Insurance contributions. They must register for VAT if their business turnover exceeds the current VAT threshold of £90,000 (for 2024/25).

4. Minimal Admin and Filing Requirements

There’s little paperwork involved with operating as a sole trader.

Besides an annual Self Assessment tax return, sole traders aren’t required to file accounts or other documents with Companies House. To fill in their tax returns, they must maintain a record of business expenses and income.

5. Privacy

Sole traders enjoy greater privacy as HMRC’s taxpayer confidentiality rules protect them. Unlike limited company directors, they are not required to provide information or publish the company’s accounts on the Companies House website.

Sole Trader Advantages:

Choosing to operate as a sole trader comes with several advantages:

1. Easy Set-up

Setting up a sole trader is fairly simple: you'll need to register as self-employed with HMRC, register for Self Assessment to pay sole trader tax and choose a business name (you don't need to register at Companies House).

2. Full Control as a Self Employed

As a sole trader, you'll have full control over your business - including how your day-to-day operations are run, how you want to scale your business and what you want to do with your after-tax profits.

You won't have to include shareholders in your decision-making process, nor be concerned about regulations that limited companies need to abide by. As a sole trader, you may also claim tax free childcare.

3. Ease of Termination or Transition

The process for terminating a sole trader business is fairly simple: you'll need to notify HMRC that you've stopped being self-employed, finalize your income tax, pay Capital Gains Tax (if applicable) and offset the costs of closing down against your tax bill.

It's easier and cheaper compared to other business structures. If you were to close down your limited company, you'll need to notify HMRC and complete a final Corporation Tax return. In addition, you need to apply to strike off your company, start a Members' Voluntary Liquidation or arrange the liquidation of your company, depending on whether your company is solvent or insolvent.

It's also easier to transition from a sole trader to a limited company, rather than the reverse.

Sole Trader Disadvantages:

1. Unlimited Liability

It's often said that as a sole trader, you are your own business.

That's because unlike a limited company, a sole trader business isn't a separate legal entity; the law doesn't distinguish between the individual running the business and the business itself. You're personally liable for the debts that your business incurs, and your personal assets can be seized to pay off these debts.

2. Tax Inefficiency

You may benefit from greater tax savings if you run your business as a limited company, particularly if your profits go above a certain threshold. That's because limited companies pay 19% Corporation Tax on their profits, compared to the 20-45% Income Tax that sole traders pay on their profits.

In addition, a limited company offers greater flexibility for tax planning. Directors can minimize their personal tax and National Insurance Contributions by paying themselves a combination of a salary and dividends, or defer tax by reinvesting surplus income or withdrawing their profits at a later tax year. In comparison, sole traders have less flexibility to work around the tax system.

3. Limited Resources and Expertise

Running a business on your own means you have limited resources and skills compared to larger businesses or those with multiple employees. You may face challenges in handling all aspects of the business, such as accounting, marketing, operations, and customer service, which can be overwhelming and may lead to inefficiencies.

The key to getting this right is to delegate or outsource non-core activities, such as accounting or administrative tasks wherever possible, so you'll have more time on your hands to focus on growing your business.

A sole trader is a type of business where you run and manage the business by yourself. You can be a sole trader as your only job or while working for an employer. You need to set up as a sole trader if:

1. Starting a New Business: If you are launching a new business and you plan to be the sole owner, setting up as a sole trader is an ideal choice.
2. Freelancing or Contracting: Freelancers and contractors often operate as sole traders. If you offer services independently, such as graphic design, writing, consulting, or any other freelance work, you should register as a sole trader.
3. Earning from Multiple Sources: If you earn income from multiple streams, such as a part-time job alongside a side business or freelance work, you should set up as a sole trader.
4. Providing Services: If you provide services to the public, such as plumbing, electrical work, personal training, or any other service-oriented job, setting up as a sole trader is necessary.
5. Selling Products: If you start selling products, whether online or through a physical store, and you're the sole owner, you should register as a sole trader.

A sole trader business must register for a self-assessment tax return if:

• they earn more than £1,000 in a single tax year,
• need to prove that they are self-employed (e.g. to claim Tax-Free Childfree or other benefits), or
• want to make voluntary Class 2 National Insurance payments to claim tax allowances and benefits.

A business owner needs to comply with HMRC rules once they register as a sole trader, which include:

• maintaining business records and records of expenses,
• completing a self-assessment tax return annually,
• paying tax on profits and National Insurance, and
• registering for VAT once your turnover exceeds £90,000.

Self-employed construction contractors and subcontractors should also register for the Construction Industry Scheme (CIS).

• Sole traders can trade under their names but cannot include the terms "limited company", "LLP", "limited", "limited liability partnership", or "plc".
• The name also cannot suggest a connection to the government or local authorities, may not be offensive and may not be the same as another registered business or existing trademark. You'll need to check the UK Intellectual Property Office trade marks register.
• Ensure that your proposed name isn't the 'same as' an existing name. Do a check using the company name availability checker tool on Gov.uk.
• The business name shouldn't be offensive, nor contain sensitive words and expressions. For further information on sensitive words or names you should avoid, check out these resources on Gov.uk.

A sole trader can trademark their business name to protect their intellectual property.

You may be required to list this name on your business stationery or official documents.

Registering as a sole trade involves several steps. By following the process outlined below, you can ensure that your business is properly registered and compliant with the necessary regulations.

1. Choose a Business Name
2. Keep Records
3. Register for Self-Assessment
4. National Insurance Contributions
5. VAT Registration (If Applicable)
6. Set Up a Business Bank Account
7. Consider Professional Advice

1. Choose a Business Name

You need to choose a name for your sole trader business. While you can trade under your own name, a unique business name can help you stand out. It's important to select a name that is unique and does not infringe on any existing trademarks or business names. Conduct a thorough search to ensure the availability of your chosen name.

2. Keep Records

As a sole trader, maintain detailed records of your business income and expenses. This includes:

• Invoices and receipts of all sales and income
• business expenses‍
• VAT records if you’re registered for VAT‍
• PAYE records if you employ people
• Records about your personal income
• Your grants, if you claimed through the Self-Employment Income Support Scheme

Keeping records will help you with tax calculations, reporting, and ensuring compliance with HMRC requirements. Use accounting software or hire a sole trader accountant if necessary.

3. Register for Self Assessment

You must register for self-assessment with HMRC to report your business income and pay the appropriate taxes.

4. VAT Registration (If Applicable)

If your annual turnover exceeds the VAT registration threshold (currently £90,000 as of 2024), you must register for VAT. VAT registration involves additional responsibilities, such as charging VAT on eligible sales and submitting VAT return to HMRC.

5. National Insurance Contributions

Sole traders are required to pay Class 2 and Class 4 National Insurance contributions. Class 2 contributions are a flat rate paid weekly or monthly, depending on your income. Class 4 contributions are based on your business profits and are paid as part of your self-assessment tax return.

6. Set Up a Business Bank Account

Though not legally required, having a separate business bank account is recommended. It simplifies your accounting process and keeps personal and business finances distinct.

7. Consider Professional Advice

While it is possible to register as a sole trader independently, it's advisable to hire an accountant for self-employed or business advisor. They can guide you through the registration process, help you understand tax obligations, and provide valuable insights to ensure your business is set up correctly

Cost of Setting Up a Sole Trader Business

Setting up as a sole trader is free. There are no registration fees with HMRC; you simply need to register for Self-Assessment. It's important to remember that you’re personally responsible for any business debts. Many sole traders choose to hire accountants to manage tasks like tracking invoices, handling bookkeeping, managing expenses, and dealing with tax obligations.

As a sole trader in the UK, you have specific tax responsibilities that you must fulfill to ensure compliance with HMRC regulations.

1. Income Tax

As a sole trader, you are required to pay income tax on your business profits for each tax year, which runs from 6th April to 5th April the following year. Your taxable income is calculated by subtracting allowable business expenses from your total income.

• Personal Allowance: You are entitled to a personal allowance, which is the amount of income you can earn before paying tax. For the tax year 2024/25, the personal allowance is £12,570.
• Income Tax Rates: Income above the personal allowance is taxed at different rates:
  • Basic rate (20%) on income up to £50,270.
  • Higher rate (40%) on income between £50,271 and £1,25,140.
  • Additional rate (45%) on income over1,25,140

2. National Insurance Contributions

As a sole trader, you must pay National Insurance contributions based on your profits. There are two types of NICs you need to be aware of:

Class 2 NICs:

• Paid if your profits are above the Small Profits Threshold (£6,725 for the tax year 2024/25).
• Voluntary contribution at fixed weekly rate of £3.45 for profits below £6,725

Class 4 NICs:

• Paid if your profits are above £12,570.
• 6% on profits between £12,570 and £50,270.
• 2% on profits over £50,270.

3. Self Assessment Tax Return

You must complete and submit a Self Assessment tax return annually, detailing your income and expenses. The deadlines are:

• Paper Tax Returns: 31st October following the end of the tax year.
• Online Tax Returns: 31st January following the end of the tax year.

4. Business Insurance

While not legally required, obtaining appropriate business insurance can protect you against potential risks. Consider:

• Public Liability Insurance: Covers claims made by the public for injury or damage caused by your business activities.
• Professional Indemnity Insurance: Protects against claims of negligence or mistakes in services you provide.
• Employer’s Liability Insurance: Required if you hire employees.

Freelancers:

Individuals who offer services like writing, graphic design, or consulting independently.

Small Retailers:

‍Owners of local shops or online stores selling goods directly to customers.

Artisans and Crafters:

Individuals who create and sell handmade products like jewelry, pottery, or artwork.

Consultants:

Professionals offering specialized advice in fields such as management, marketing, or IT.

Tradespeople:

Plumbers, electricians, builders, or gardeners operating their own businesses.

Service Providers:

Hairdressers, beauticians, personal trainers, or tutors offering services to clients.

Online Sellers:

Individuals selling products through platforms like eBay, Etsy, or Amazon.

Photographers:

‍Freelance photographers offering their services for events, portraits, or commercial projects.

Sole traders are critically important to the UK economy. However, many businesses start trading without understanding how much tax they must pay, which tax records to keep, and where and how to register their new business. If you need help with your assessment, get in touch with us. We can help you make the most of your money.

FAQs on Sole Traders

Do sole traders pay corporation tax?

No, sole traders do not pay corporation tax. They pay income tax on their business profits.

Do sole traders pay National Insurance?

Yes, sole traders with annual profits of £12,570 or more usually pay Class 2 and Class 4 National Insurance contributions.

Can a sole trader be VAT registered?

Yes, a sole trader can be VAT registered. They must register if their taxable turnover exceeds £90,000, but they can also choose to register voluntarily.

Can sole traders hire employees?

Yes, sole traders in the UK can take on employees. While the term "sole trader" might suggest that the business consists of only one person, it actually refers to the ownership structure rather than the number of people working in the business. It is a legal obligation to enroll in a PAYE scheme and provide a workplace pension if sole traders hire employees.

Do sole traders need to register at Companies House?

No, sole traders do not need to register at Companies House. They only need to register with HMRC for tax purposes.

What is a sole trading concern?

A sole trading concern is a business owned and run by one person. The owner controls all operations, keeps the profits, and is personally responsible for the business's debts.

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Becoming a sole trader in the UK is a great way to start your entrepreneurial journey. With its simple setup, low costs, and complete control over your business, it offers many advantages. By following the steps outlined in this guide, you can establish yourself as a sole trader and manage the challenges effectively. Remember, thorough planning and proper management are key to your success as a sole trader. Consider hiring a sole trader accountant for expert advice on managing finances and staying compliant with tax rules. With careful planning and professional guidance, you can achieve lasting success as a sole trader.