When starting a business in the United Kingdom, 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, registration process, and tax considerations for sole traders. Let's first understand what is a sole trader.
What is a Sole Trader?
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 proprietor is a self-employed person who is also the exclusive owner of a business. The individual is entitled to all business profits of the business after tax has been paid and is personally responsible for all losses.
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.
How to Become a Sole Trader in UK?
Sole traders run their businesses as individuals, meaning they can keep all their profits and are responsible for all the losses. Several rules apply to sole trading, including naming conventions and rules on business operations, including the requirement to register for self-assessment tax.
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 £85,000.
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.
How to Register as a Sole Trader?
Registering as a sole trader in the United Kingdom involves several steps. By following the process outlined below, you can ensure that your business is properly registered and compliant with the necessary regulations.
- Inform HMRC - The first step is to inform HMRC that you are starting self-employment. You will need to register for self-assessment and Class 2 National Insurance contributions. This can be done online through the HMRC website or by contacting the HMRC helpline.
- Choose a Business Name - Next, you need to choose a name for your sole trader business. 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.
- Keep Records - As a sole trader, it's essential to maintain accurate records of your business income, expenses, and any relevant receipts. This will help you with tax calculations, reporting, and ensuring compliance with HMRC requirements.
- Register for Self-Assessment - You must register for self-assessment with HMRC to report your business income and pay the appropriate taxes. You can register online through the HMRC website or by completing the relevant forms and submitting them to HMRC by post.
- 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.
- VAT Registration (If Applicable) - If your annual turnover exceeds the VAT registration threshold (currently £85,000 as of 2024), you must register for VAT. VAT registration involves additional responsibilities, such as charging VAT on eligible sales and submitting VAT returns to HMRC.
- Consider Professional Advice - While it is possible to register as a sole trader independently, it's advisable to hire a professional accountant 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.
What are the Characteristics 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.
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 £85,000 (for 12 months ending in 2022/23).
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.
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:
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.
Read more advantages of being a sole trader for unlimited growth and the ease of setup.
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.
Sole Trader Examples:
- Freelance writers
- Virtual assistants
- Business consultants
- Financial planners
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.
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