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What is a sole trader?

Have you been considering starting up your own business? The ease of setting up as a sole trader is what draws most first time contractors to structuring their business this way, along with the enticement of profits a sole proprietor is entitled to. 

200 000 sole traders started up in 2019 alone, bringing the total number of sole proprietorships in the UK to 3.5 million. 

We run through the details of what it means to be a sole trader, the associated benefits and potential pitfalls.

Sole Trader Definition

A sole trader is defined as a self-employed person, who is the sole owner of their business. They remain wholly responsible for debts incurred through the business, but also solely privy to profits made, after the deduction of income tax and expenses. This structure is not regarded as a separate legal entity, which is a considerable difference to the limited company business structure, where your business is a separate entity to yourself. 

Income tax becomes payable after the personal allowance threshold is reached. The rates of income tax start at 20% for any amount from £12,501 – £50,000, where after the rate becomes 40%. Any income above £150,000 carries a 45% income tax rate. 

The simpler registration process is another major drawcard. As a sole trader, there is no need to register with Companies House; the only registration process you need to fulfil is a declaration of self-employment to HMRC, which in turn will require you to submit a Self-Assessment Tax Return (SATR).

Ensure you have obtained your Unique Taxpayer Reference (UTR), as this is required to fill in the SATR. 

Choosing to complete your SATR electronically affords a later submission deadline, for example: HMRC issues the SATR on the 6th April; completing a paper return carries a deadline of 31st October, while an electronic return allows for completion up to the 31st January of the following year.

Sole Trader Business Responsibilities

Once you’ve informed HMRC of your self-employed sole trader status, you are responsible for making class 2 (for profits over £6,475 per annum) or class 4 (for profits over £9,500 per annum) NIC payments and income tax on the profits you make. You are also responsible for completing the Self-Assessment Tax Return annually.  

Sole trader VAT thresholds trigger when you earn in excess of £85 000, requiring that you register for VAT. If you earn less than £150 000 per annum, you can also opt to join the Flat Rate VAT scheme, where you apply a fixed rate percentage to your VAT inclusive turnover. 

Keeping detailed financial records is a requirement for any business entity. You need to keep track of all sales and takings, along with any allowable business expenses you’ve incurred among other financial records. At times it may be tricky to keep a new business afloat (especially when you’re just starting out) and maintain accurate financial records; it’s for this reason we recommend appointing an accountant to keep tabs on your financial records to keep you tax-compliant.

Sole Trader Tax UK

A consideration you’ll need to make before you decide to become a sole trader is whether you’re willing to take on the financial risk of this specific business structure. A sole trader is not a separate legal entity, which means you are personally liable for business debts. The good news is that if you aren’t taking on considerable debt, this option bears less risk.

The use of the term ‘sole’ should not be misconstrued, in that you are still fully allowed to hire employees as a sole trader. Nothing about the business structure will change, i.e. you are still solely responsible for debts. If you choose to hire staff, you will also be responsible for the payment of their NICs, income tax as well as registering for Pay As You Earn (PAYE) tax and making the relevant payroll submissions to HMRC.

How does a sole trader pay tax?

The Self-Assessment Tax Return (SATR) is your way of submitting tax as a sole trader. You will also need to pay your NICs and income tax. Once you’ve registered for Self Assessment, HMRC will send out your notice following the end of each tax year, and you have until 31st October of the same year to complete it if you are submitting a paper return, or 31st January the following year  if you’re completing it online. Any outstanding amounts become payable on 31st January of the following year. 

The Government Gateway is where you will register for the SATR and submit your return.

As soon as you become an active payer for SATRs, you will need to remember to make account payments. Your accountant will be familiar with the specific dates that you as a sole trader are mandated to pay taxes on and help you to plan for it.

There are two important dates to bear in mind for financial planning as a sole trader; 31st January is when you are due to pay income tax for the previous financial year. If your tax liability exceeds £1,000 you will be required to make payments on account towards your next years tax liability. HMRC deal with this by taking your tax liability and splitting this into two payments. This means that in addition to your liability for the previous tax year, you will need to pay an additional 50% on 31st January towards the next years liability.  

Six months on – the 31st July – is when HMRC requires you to pay the second payment on account (the remaining 50%). This means that you may find yourself paying 150% of your tax liability in the first year if your tax liability exceeds £1,000. This can come as a surprise to many self-employed contractors and  will always require careful financial planning. It may be a good idea to consider a sole trader tax fund to assist you in settling any amount owed to HMRC.

Another benefit associated with a sole trader structure is that you can withdraw cash from your business without tax implications. Keep your business account separate from your personal account, as this will help you claim tax relief on certain charges and help you streamline eligible expense claims that have been wholly and exclusively acquired for business purposes. 

Liability of a sole proprietor

A considerable setback of operating as a sole trader is unlimited liability. You remain personally responsible to repay any debts incurred, because you are not regarded as a separate legal entity. This could place your personal assets at risk and see you remain liable for repayments in the event you have no income from trade. With considered financial planning, this risk can be managed. Keeping overheads low and not committing to unmanageable financial obligations will contribute to a managed liability.

Expanding a sole proprietorship

If there is an upturn in business, a sole proprietorship may not be able to meet your needs any longer. Similarly, if a need becomes evident for a second shareholder, or succession plans – there is the option to change structure from sole trader to limited company. 

In this instance, remember that you will no longer be charged income tax; you would be responsible for corporation tax as a limited company director.  

 Whichever structure you decide to operate through, we always recommend carefully considering the advantages and disadvantages of each business entity, taking into account your personal circumstances.

If you need any advice on setting up your own limited company, our specialists are available to help you. Reach us on 01253 362062 or click here to request a call back.